THE BIG PICTURE: Why China’s economy is still improving

Our international economist at Commonwealth Bank, Richard Grace, has made a good point about the recent release of the HSBC “flash” purchasing managers’ index for China. The PMI lifted from 48.2 to 49.5 in July.

However, despite the improvement, the authors of the report categorised the result as showing a “contraction” of the manufacturing sector at a “slower rate”. But, on the same day, the Reserve Bank governor presented a graph showing the close relationship between the PMI and industrial production. The key point is that industrial production is actually growing at a near 10% annual rate.

So which observation is correct? Well, the first thing to note is that the PMI does closely track growth in industrial production. The problem appears to be in how to interpret the PMI result.

Rather than suggesting that the manufacturing sector is actually going backwards, the PMI should be seen as a gauge of whether production growth is likely to pick up or slow further in the future. That is, the PMI is a “summary measure showing the prevailing direction of change”. So the latest result suggests that production will pick up pace modestly from the current 9.5% annual rate.

In late 2008 through early 2009, when Chinese production was growing at an 18% annual rate, the PMI was near 57. Growth has almost halved since, with the PMI just below 50. So the PMI is useful in highlighting direction rather than defining a specific magnitude of growth. But certainly the relationship between the PMI and production growth is close, so it’s worth following the PMI results. Indeed, PMI readings for other countries have displayed similarly good ‘leading indicator’ properties.

The HSBC PMI measure is derived by surveying around 420 small, medium and large manufacturers, with the survey sample representative of the broader industry sector. Respondents are asked to compare variables like production compared with the previous month and the index shows the net difference between higher/better responses and lower/worse responses.

The bottom line is that conditions are improving modestly in China, leaving the door wide open for stimulus.

The week ahead

In Australia over the coming week, investors can look forward to a spattering of ‘top shelf’ economic indicators, although the next interest rate decision is still another week away. In the US, the monthly jobs data hogs the limelight but there is a solid schedule of releases in the early part of the week.

In Australia, the week kicks off on Monday with data on new home sales from the Housing Industry Association.

Home sales have drifted higher over the past two months from 11-year lows, but activity is still far from ‘normal’.

On Tuesday, not only is building approvals data on the menu but so is the Reserve Bank’s money supply and credit figures. Credit (or loans outstanding) has been creeping higher over the past eight months with the business sector leading the way. We tip another 0.5% increase in credit, taking annual growth to a three-year high of 4.4%. Building approvals are tipped to have fallen by 15% in June.

On Wednesday, the Performance of Manufacturing index is released together with the RP Data/Rismark Home Value index. Manufacturing activity rose in June in response to rate cuts and firmer consumer spending and some consolidation is likely in July. And the good news may extend to home prices given that the daily measure of home prices has been drifting higher.

On Thursday, retail trade data is released for the June month and June quarter. It’s clear from a range of sources that rate cuts, lower petrol prices and government handouts are working their magic in lifting consumer spending.
We tip a 0.9% lift in sales for the month and 1.5% inflation-adjusted lift in June quarter sales.

Also on Thursday, the June trade figures are issued. We expect a flat result – that is, either a small deficit or surplus. And, on Friday, the Performance of Services index is released. The services gauge hasn’t been above the 50 line that divides expansion from contraction for five months.

In the US, the week kicks off on Monday with regional manufacturing gauges from Chicago and Dallas. And, on Tuesday, personal income, employment costs, consumer confidence and a measure of home prices are all slated for release. Economists tip modest gains of 0.4% for personal income, 0.1% for spending, 0.5% for employment costs and 0.3% for home prices.

Also on Tuesday, the Federal Reserve begins the first day of a two-day meeting while the Chicago purchasing managers index (PMI) is issued – the precursor to the national index. That national PMI is released on Wednesday and economists tip a modest improvement from 49.7 to 50.2 in July.

On the same day, the ADP employment gauge is expected to show 120,000 jobs created in July. And other data is expected to show a slight lift in car sales and 0.4% increase in construction spending.

On Thursday, data on factory orders is released alongside figures showing weekly claims for unemployment insurance and a gauge of activity in the New York region.

And on Friday – the release that most will be waiting for – figures on non-farm payrolls or employment.

Economists tip a better, but not great, outcome with jobs up by 100,000. The unemployment rate is expected to be stable near 8.2%. And, on the same day, the ISM services gauge is released.