Key points:

• Deepening downturn signalled by newly-launched PMI survey.
• Services and manufacturing business conditions deteriorated at record rates in January.
  Job losses accelerated.
• Deflationary pressures intensified.

New survey launched:

Today sees the first public release of the Nomura Japan Services PMITM, a new monthly survey of tertiary sector business conditions based on information collected from a representative sample of 400 companies, compiled by Markit. The survey has been piloted since September 2007.

The new survey is important as services account for approximately 71% of GDP, with around 47% accounted for by the private sector services that are covered in the PMI.
The new service sector survey complements the existing, highly-regarded manufacturing PMI, which has been compiled by Markit on behalf of Nomura and the Japanese Materials Management Association (JMMA) since 2001, and which has provided an accurate advance guide to manufacturing sector business conditions.

Furthermore, the combination of the manufacturing and service sector PMI data into “composite” survey indices provides a comprehensive insight into private sector business conditions, covering some 68% of Japanese GDP.

The manufacturing PMI is published on the final working day of each month, while the service sector and composite data will be published on the third working day of every month.

Output and demand:

A steep downturn of service sector activity was signalled in January as business activity declined at the fastest rate seen over the survey’s 17-month history. Some 44% of service companies reported lower activity levels compared with December while just 7% reported an improvement. As a result, after allowing for seasonal influences, the service sector Business Activity Index fell from 37.0 to 34.1. Any reading below 50 signals contraction on the previous month. Activity in the sector has now fallen for 13 successive months, with the rate of decline accelerating over this period.

Combined with the seven-year record rate of output contraction registered by the equivalent manufacturing survey, the latest PMI data point to a deepening of the recession in January. The Composite Output Index slumped from 33.1 in December to 30.1 in January (the lowest reading in the 17-month series history). The index is consistent with the annual rate of decline of GDP gathering pace from approximately 1.5% in Q4 to 2% or more in January.

The deterioration in service sector activity in January was driven by the largest monthly decline in new business recorded by the series to date, as companies reported weakened demand from both business and household sectors.

However, although falling sharply, business activity and new business in the service sector remained more resilient than in manufacturing, reflecting the latter sector’s greater dependence on exports. PMI data for January are consistent with manufacturing exports continuing to fall at an annual rate in excess of 30%.

Employment and capacity

Service providers cut employment at the fastest rate yet recorded by the survey, in line with the downturn in demand. Just 6% of companies reported higher staffing levels compared to 16% reporting a reduction. However, the rate of job shedding remained considerably lower than the seven-year record pace seen in manufacturing. Combined manufacturing and service sector employment has now fallen for six successive months, with the rate of job losses gathering pace over this period.

Of concern, current activity levels in the service sector were only supported by the sharpest reduction in backlogs of work yet recorded by the survey, and this further depletion of outstanding business suggests that operating capacity (and therefore employment) will continue to be reduced in coming months. A similar situation exists in manufacturing, where backlogs of work were also depleted at a record pace in January, taking the composite index of backlogs of work for the two sectors down to a new low.

Prices

Input costs in the service sector fell for the second month in a row in January, dropping at the fastest rate seen by the survey to date, largely reflecting lower fuel costs, reduced interest rates and downward pressure on staff costs. The fall in input costs is in marked contrast to the buoyant rate of increase seen throughout much of last year.

With manufacturers’ input prices falling at the fastest pace for seven years in January, the composite measure of input prices for the two sectors hit a new low in January, registering a drop in costs for the second consecutive month.

Although lower input costs provide some relief to service providers, pressure on profit margins remained intense as weak pricing power meant prices charged for services also dropped at the fastest pace yet recorded by the survey in January, down for the eleventh consecutive month.

As manufacturers were also forced to cut their selling prices at a the sharpest rate for five-and-a-half years in January, the combined measure of output prices slumped to a new low in January, signalling falling prices for goods and services for the fifth successive month.

Outlook

Looking ahead, the situation is more likely to deteriorate rather than improve. The January survey found that some 46% of service providers expect their business activity levels to be lower in 12 months’ time, compared to just 14% expecting business levels to improve. This is the most pessimistic outlook yet recorded by the survey.

Comment:

Commenting on the PMI data, Minoru Nogimori, Economist of the Financial & Economic Research Centre at Nomura, said:

“The ongoing decline in the Nomura Japan Services PMI confirms the deterioration in economic activity has now spread to a wide range of industries. With manufacture sector in the midst of unprecedented cuts in production heading, service sector is also showing clear downturn.

Moreover, price related indices continue to decline. This indicates prices are beginning to trend lower and concerns that Japan will re-visit its deflationary past are highlighted.”

Commenting on the PMI data, Chris Williamson, Chief Economist of Markit, said: “The new service sector survey will complement the manufacturing PMI survey to provide the earliest comprehensive indication of economic trends in Japan, and also allow easy international comparisons with other countries for which PMI data are available. The downturn in Japan has clearly deepened in January, and there is no sign yet of the recession bottoming out.”