Euro-area manufacturing growth accelerated to a record in December, capping a solid year for factories which is now eating into production capacity.
With export demand strengthening, IHS Markit’s monthly report on manufacturing showed both new orders and output were the strongest in 17 years. Germany’s gauge rose to a record and France improved. Global growth also got a boost from a solid reading in China’s manufacturing sector.
But while the reports highlight momentum in manufacturing heading into 2018 after the world economy’s best performance in three years, they also point to a squeeze that could put a limit on expansion. Supply constraints — meaning companies find it hard to keep up with demand — were highlighted in the Purchasing Managers Index for almost every major economy, including China, Germany, France and the U.K.
In the euro area, IHS Markit said “robust intakes of new business tested capacity” and there was a jump in backlogs of work as factories struggled to keep up. In Germany, it said this “poses a risk to the sector’s ability to kick on.”
With industry at its limits, there are implications inflation, which remains below the European Central Bank’s target of just under 2 percent. Bundesbank President Jens Weidmann, who wants to set an end-date for monetary stimulus, recently cited regional bottlenecks as setting the stage for stronger wage growth.
“The missing element has been sustained higher inflation,” said Chris Williamson, chief business economist at Markit. “But the near-record incidences of supply-chain delays seen toward the end of 2017 indicate that pricing power is shifting from the buyer to the seller, suggesting upward price pressures are gradually returning.”
At the same time, input costs remain “elevated” across a number of economies, partly reflecting higher raw material prices. Larry Hatheway, chief economist at GAM, highlighted the return of inflation in his latest outlook for 2018.
“A key development to watch out for in 2018 is the potential advent of accelerating inflation,” he said. “It matters most because it is almost entirely unanticipated by markets, yet seems likely from the perspective of macroeconomic conditions.”
In China, the Caixin factory PMI rose to 51.5 in December from 50.8 in November, marking the best reading in four months. The report noted faster growth of output, total new work and export sales, as well as an increase in backlogs of work. An official PMI weakened slightly, though remained above the key 50 level that signifies expansion.
China’s overall economic growth may slow in 2018 after accelerating last year, though the government has signaled it will accept slightly weaker expansion as it deals with what it says are “critical battles” of financial stability, poverty and pollution.
There were signs of weakness elsewhere in Asia, with factory indexes in Indonesia, Malaysia and South Korea dipping below 50 during December.
Still, the global economy is forecast to expand 3.7 percent this year, slightly faster than the 3.6 percent pace estimated for 2017, according to the IMF’s most recent projections. The euro area will cool slightly from 2.3 percent this year, but still record growth above 2 percent.