Economic growth across the four largest developed economies — US, UK, eurozone and Japan — accelerated to the fastest in 13 months in May, according to flash Purchasing Managers' Index (PMI) data compiled by S&P Global. Growth was driven entirely by services as manufacturers continued to report broadly stalled production.
Spending continues to shift from goods to services, bringing with it a change in inflationary pressures. Prices for goods are falling amid excess supply, while prices for services continue to rise at a solid pace as post-pandemic demand exceeds supply. Input costs and selling prices continue to rise at elevated rates by historical standards, albeit having cooled markedly from last year's peaks.
Central bank rhetoric will need to be watched for assessments of the stickiness of inflation and the resilience of growth. The strength of the service sector is likely to add to pressure on central banks to keep interest rates higher for longer, and in some cases even reach higher terminal rates, which will add to the likelihood of economic growth cooling as the year proceeds.
Economic growth revival driven by services
Business activity rose across the four largest developed world economies, also known as the G-4, for a fourth month running in May, according to provisional flash PMI data. The rate of growth accelerated to the fastest since April 2022.
Growth was skewed heavily towards the service sector, where business activity rose at the fastest rate for 14 months across the G-4 in response to an acceleration in the growth of incoming new business, in turn reflecting resurgent post-pandemic demand. In contrast, manufacturing output fell slightly when measured across the G-4, fueled by a steep and accelerating rate of loss of new orders.
Growth was recorded in all four economies for a fourth straight month, indicating a synchronized and broad-based improvement geographically.
The strongest expansion was recorded in Japan, where output across manufacturing and services rose at the highest rate since October 2013. Service sector growth hit a new survey high, accompanied by the first rise in factory output for 11 months.
Strong and accelerating growth was also recorded in the US, where output across both sectors rose at the steepest rate for 13 months. An increasingly strong surge in US services activity was joined by a further rise in manufacturing output, albeit with the rise in factory production growth losing momentum to show only a modest gain.
In contrast, growth slowed in Europe, with expansions losing some steam from recent peaks in April in both the eurozone and UK. Still, both economies continued to report robust growth, albeit in both cases with service sector upturns losing some pace from impressive levels in April and with both economies reporting increasingly marked manufacturing downturns.
Demand shifts further from goods to services
Inflows of new business across the G-4 service sector grew at the sharpest rate for just over a year, rising strongly in all four economies. New orders at factories, meanwhile fell for a 12th successive month with the rate of decline the fastest since February. Only Japan saw an increase in new orders for goods and the rise was only slight. The steepest decline was witnessed in the eurozone.
The diverging new order trends also led to a further contrast in backlogs of work, which rose for a fourth consecutive month in the service sector but fell in manufacturing at a rate not seen since the Great Recession, barring pandemic lockdown months. Backlogs fell in manufacturing in all four economies in May but rose in services in all cases.
The survey data adds to signs of a shift of spending away from goods towards services. This likely reflects the further reopening of the global economy this year that allows unfettered cross-border travel for the first year since 2019. This shift in spending is leading to the development of excess capacity in manufacturing while straining capacity in the service sector.
Prices fall in manufacturing but rise sharply again for services
Varying demand conditions and capacity constraints also played a role in determining inflationary trends. In manufacturing, the recent softening of demand for components has led to discounting and has been accompanied by lower energy costs. Input costs consequently fell on average across the G-4 for the first time in almost three years, dropping all cases except Japan.
These lower costs have been passed on to customers as goods producers seek to shore up weaker-than-anticipated sales. As a result, average selling prices for goods across the G-4 rose in May at the slowest rate since October 2020. Selling prices fell in the eurozone and barely rose in the US, leaving Japan and the UK with the steepest rates of increase, though even in these economies the rate of goods inflation moderated.
Inflationary pressures in the service sector proved more stubborn. Although average prices charged for services across the G-4 service sectors declined from April, the rate of increase remained elevated by historical standards. The rate of increase greatly exceeded the survey average seen in the decade leading up to the pandemic and any prior peaks seen over this period by a wide margin. Particularly stubborn service sector inflation was seen in the UK and eurozone, though elevated rates also continued to be recorded in the US and Japan.
In contrast to manufacturing, which saw improved supply and weakening demand, the service sector saw further instances of companies being constrained by a lack of labor while simultaneously reporting resurgent demand, pushing both costs and prices higher.
Recession averted, for now
The common theme in the May flash PMI data for the major developed economies is that a post-pandemic revival of spending on services has helped sustain robust economic growth midway through the second quarter. This upsurge in demand has strained capacity at service providers, notably via difficulties in hiring, and led to stubbornly high cost and selling price inflation rates.
Spending has diverted away from goods, leading to a situation of excess supply which has fueled increasing instances of price discounting as factories seek to reduce inventory levels.
A key question for the outlook relates to the sustainability of this tailwind from the pandemic, which has spurred a shift in spending from goods to services. Higher interest rates are likely to take their toll eventually, especially if these signs of resilient economic growth encourage further rate hikes.
In manufacturing, destocking is likely to act as less of a drag once inventories are normalized, probably later in 2023. Still, just how adversely affected demand for goods will be by other factors, such as the increased cost of living and higher interest rates, is yet unclear.
We retain the impression from the data that, while recession appears to have been averted for now, there remains a strong possibility of substantially weaker economic growth later in the year as the impacts of higher interest rates — which are less likely to have peaked given May's flash PMI data — feed through to the economy.
Purchasing Managers' Index data is compiled by S&P Global for more than 40 economies worldwide. The monthly data is derived from surveys of senior executives at private sector companies and is available only via subscription. The PMI dataset features a headline number, which indicates the overall health of an economy, and sub-indices, which provide insights into other key economic drivers such as GDP, inflation, exports, capacity utilization, employment and inventories. The PMI data is used by financial and corporate professionals to better understand where economies and markets are headed and to uncover opportunities.
Data and insights for this article were compiled by Chris Williamson, chief business economist for S&P Global Market Intelligence.
