The resilience of Manufacturing PMI through to April was surprising, given the extent to which constraints on supply and pressure on input prices have increased since the beginning of the conflict in Ukraine on 24 February. This is particularly true in Germany where, despite an industrial sector with considerable exposure to the shock, Manufacturing PMI remained well above 50 (54.6 in April 2022). This suggests that activity in the sector remained comfortably in the expansion zone, whereas industrial production contracted by 4.4% between January and March 2022.
Germany: adjusted manufacturing PMIThis conflicting message is due mainly to a methodological bias: the inclusion of delivery lags in the aggregate PMI index. This bias may be an issue when the PMI is used as a nowcast for industrial production or GDP growth.
The construction of the German Manufacturing PMI figure is based on the following weightings of the five sub-balances of Markit’s survey: 30% for manufacturing output, 25% for new orders, 20% for employment, 15% for suppliers’ delivery times, and 10% for stocks of purchases. Aggregating this way, an increase in delivery times makes a positive contribution to Manufacturing PMI, the underlying idea being that longer delivery times reflect a positive demand shock that has not been anticipated by companies. In such circumstances, it makes sense that Manufacturing PMI should increase because industrial production will increase at the same time. However, this relationship does not hold when the economy is affected by a supply disruption: in this case, the increase in delivery times will increase Manufacturing PMI, by construction, but this sends the wrong signal considering that production will be constrained by longer delivery lags.
To adjust German Manufacturing PMI for this methodological bias, one could either neutralise the contribution from delivery times (setting the figure at 50 throughout the period), or reverse its sign in the calculation of Manufacturing PMI in order to change the economic sense of an increase in delivery times. The latter approach requires some judgment as one needs to assess whether longer delivery times are demand or supply led. This may be a challenge when going back in time. With these corrections, Manufacturing PMI gives a much better reflection of recent trends in German manufacturing production. In April 2022, Manufacturing PMI with the sign reversed would have been 46.8, accurately reflecting the contraction in production.
