Factories slow down in China, Europe

From Europe to China, key elements of the global economy are gearing down as demand sags and factories hold back on production.

In the 17-nation euro region last month, a composite index of purchasing managers in manufacturing and services stayed at its lowest level in almost two years, according to London-based Markit Economics. Even exporting powerhouse Germany, long a source of strength for the troubled continent, showed signs of weakness.

A report from the U.S. Federal Reserve's regional bank in Richmond, Va., revealed that manufacturing in the central Atlantic region dropped to its weakest level since June, 2009, following dismal factory readings last week for the northeast region.

And in China, a preliminary gauge of factory strength for August slipped two ticks below 50, indicating a contraction.

But investors, already battered by plunging share prices in recent weeks, decided it could have been worse.

Stocks rallied sharply in North America amid some relief that the latest economic indicators turned out better than pessimistic forecasts. China's factory reading was interpreted by markets as a much-needed sign that China may avoid the feared "hard landing" that could come as Asia's fastest-growing economy feels the effects of a global slowdown. And some had expected steeper drops for Europe's economic measures.

Investors' hopes for the economy are also being fuelled by growing speculation that U.S. Fed chairman Ben Bernanke will use a speech in Jackson Hole, Wyo., this Friday to outline plans for another crack at stimulating American demand and preventing a double-dip recession. While U.S. stocks surged Tuesday, the greenback tumbled as investors were willing to take more risks.

"A lot of the fear over the last couple of weeks was that the global economy and the U.S. were deteriorating quickly, and I think the data overnight show that they are deteriorating, but at a slower pace," said Jennifer Lee, a senior economist at BMO Nesbitt Burns. "All things considered, we all take that as good news."

Such is life in a month that has seen a daily drumbeat of negative news raise fears that the global economy is veering dangerously close to another downturn. Still, the market response on Tuesday does not mean the slowdown in factories, which started earlier this summer and continued apace in August, won't continue.

Part of the reason investors are confident Mr. Bernanke will take action is that some of the most troubling data are coming from the U.S. manufacturing sector, which had previously been an unlikely vital engine of America's recovery.

Another report Tuesday from the U.S. Commerce Department showed America's basket-case housing sector is still stuck in the mud, with sales of new homes falling more than expected in July and a downward revision for the previous month.

As for Europe, the sovereign debt crisis and the harsh austerity measures implemented in many countries to try to contain it are crimping demand and spooking investors even in the region's strongest members.

Confidence among German investors plunged more than expected in August, to the lowest level in more than 2½ years, according to the ZEW Center for European Economic Research in Mannheim, amid fears that the European crisis will soon infect the continent's banking sector.

Also, consumer confidence in the euro zone dropped more than expected in August, the Brussels-based European Commission said Tuesday in an initial estimate, after gross domestic product in the region grew at a paltry 0.2 per cent annual pace during the second quarter.

"With little prospect of a near-term pickup in external demand and the impact of the recent financial market turbulence yet to fully feed through into activity, we cannot be too complacent about the risk of a new euro zone recession," Martin van Vliet, an analyst at financial group ING, told Reuters.

However, Mr. van Vliet added, "for the time being, we stick to our base case that the economy will flatline rather than shrink in the second half of this year."

That's in line with what most economists and Canada's top policy makers predict: slower-than-anticipated growth, but not another slump in the U.S., Europe or in Canada. Still, whether a recession looms may be a matter of semantics.

"All the data reinforce the view that the recovery is slow, but we are still not of the view there will be a recession," said BMO's Ms. Lee. "Maybe not a recession by definition, but it will certainly feel like it because unemployment will remain very high, and economic activity is growing but at a very slow rate. So it won't be another 2008 – the circumstances are different these days – but we're certainly not seeing a strong recovery."