Investors were given the clearest sign yet that the core euro zone countries are proving unequal to the struggle to keep the rest of the euro zone economy afloat, after a closely watched survey suggested that manufacturing output in Germany and France is sliding at its fastest rate in three years.
Analysts had previously hoped the surprising recent resilience of France and of Germany in particular, despite economic crisis elsewhere in the euro zone, would support peripheral euro zone economies plagued by declining output.
But Tuesdays July survey of purchasing managers by Markit Economics, which is perused every month by the European Central Bank, makes it hard for this aspiration to survive.
The weak reading of the manufacturing PMIs [purchasing managers' indexes], which generally lead the business cycle, have dampened any hopes of an imminent turnaround in the near future, Stella Wang, economist at Nomura in London, said.
The Markit manufacturing index for Germany dropped by 1.7 points to 43.3, a 37-month low. With any number below 50 signifying a contraction in output, this suggests the fall in production in one of the worlds great manufacturing powerhouses is accelerating. The French manufacturing index dropped to a 38-month low of 43.6. According to the surveys, French and German output is declining even more rapidly than in the rest of the euro zone, with the overall manufacturing index for the currency union dropping by one point to 44.1.
Neville Hill, European economist at Credit Suisse in London, said, Its clear that the stronger core of the euro area is catching down with the weaker periphery, casting a cloud over the prospect that the peripheral economies would instead catch up with the core, with output boosted by demand from their stronger neighbors.
Ben May of Capital Economics, an independent macroeconomic consultancy, said the euro zone survey points to an annual slide in industrial production (which includes natural-resource production as well as manufacturing) of 10 percent.
It appears that the loss of confidence in the sustainability of the euro is having as much of a corrosive impact on economic activity in Germany and France as it is in economies such as Spain and Italy, even if financial circumstances are very different, said Hill of Credit Suisse. He added, Although the recession is not necessarily deepening, the euro area recession is broadening.
A slight improvement in Markits service-sector index for July provided some comfort leaving the composite euro zone index of services and manufacturing unchanged on the month at 46.4, which indicated no worse than a steady and continuing contraction. However, economists regarded this as small consolation, given both the fall in the manufacturing numbers a leading indicator of the rest of the economy and the gathering pace of decline in new orders for manufacturing and services as a whole. New orders are seen as an augury of future output.
The declining prospects for Germany and France have a double importance because they raise two key questions. The first is how the peripheral economies can resurrect themselves when faced with poor demand from key export partners as well as at home. The second is how Germany and France can prop up peripheral economies tottering public finances, through euro zone rescue funds and other transnational mechanisms, if their weakening underlying economies suggest they could suffer from fiscal deterioration too.
On Tuesday Moodys Investors Service put Germany, which still enjoys a AAA rating, on negative outlook as well as two other top-rated member states, the Netherlands and Luxembourg. Moodys said that should Italy and Spain require an increase in financial aid, this burden will likely fall most heavily on more highly rated member states if the euro area is to be preserved in its current form.
The Eurofirst 300 index of euro zone stocks fell 0.6 percent on Tuesday to 1,019, partly in response to the PMI. The yield on the German 10-year bond rose by 8 basis points to 1.26 percent although it remains extremely low by historical standards.