Global economy surge may have peaked

The racing pulse of the global private sector slowed in May, business surveys show, with cooler US activity outweighing another acceleration in Europe.

At the same time, higher input prices fanned inflation concerns around the globe.

The monthly healthcheck, gleaned from the responses of 10,000 manufacturing and service-sector firms in the United States, Europe and Asia, underlines a dilemma for monetary policy-makers and investors that has fueled recent volatility in financial markets.

While the surveys suggest the latest upsurge in the global economy may have peaked, world growth looks to have crested at very high levels close to 5 per cent. At the same time, lagged inflationary impacts from skyrocketing commodity costs need close watching.

JP Morgan, which compiles a global Purchasing Managers Index from the national surveys and uses it as a proxy for world gross domestic product growth, said the index fell 1.5 points in May to 58.8.

But it said that with readings above 50 denoting expansion of the private sector economy, this still implied annualized global GDP growth of some 4 to 5 per cent last month.

"Despite this setback, the PMI still points to a strong, broadly based economic expansion," said David Hensley, director of global economics coordination at JPMorgan in New York.

That level of world growth compares with the International Monetary Fund's forecast for all of 2006 of some 4.9 per cent, close to the 2004's peak.

The question for central banks is whether to squeeze borrowing costs much higher to ensure firms' input costs do not seep into consumer prices and inflation expectations, or whether to be patient and assume a cyclical slowdown is underway and will cool prices anyway.

The US economy is seen as more advanced along the economic cycle than the euro zone or Japan and signs of US slowing sharpen the dilemma for the Federal Reserve -- which has already hiked rates to 5 per cent from 1 per cent over two years.

Fed Governor Susan Bies stressed that point on Tuesday. "We are in a period where we're in transition and transition means we don't exactly know where we are going to stop (raising interest rates)," she told a bankers group.

She added that previous rate rises will also slow the economy with a lag, but this may not be reflected in prices.

"While that (prior tightening) may slow the economy, we're seeing that (core) inflation in the last three quarters has been running in the high 2 per cent range, which personally makes me very uncomfortable." With US stocks hit hard again on Tuesday by signs the Fed will opt for more rate rises even as the economy is slowing, traders too were juggling the risks.

"The bond market is saying that economic growth has peaked, but the jury is still out on inflation," said Joseph Balestrino, strategist at Federated Investors in Pittsburgh.

The argument for tighter credit from the European Central Bank -- which has raised rates twice, to 2.5 per cent from 2 per cent since December -- may seem clearer given euro business surveys continue to show acceleration in activity and prices.

But with European economic growth still highly dependent on exports, a looming slowdown in the world's biggest economy will likely affect the euro zone outlook further down the line too.

The ECB is widely expected to raise rates again this Thursday. But European politicians hope the bank will take account of the growth impact in deciding its action.

"In case the ECB will take the decision that the ECB is set to take, the central bank would consider by doing so any decision that would not harm economic growth," Jean-Claude Juncker, chairman of the 12-nation Euro group of finance minsters, said on Tuesday.

The breakdown of Tuesday's global PMI report showed a US-driven retreat in new orders of more than two points to 58.1. This was offset by jump in job growth to 55.2 from 54.9.

But the figure likely to have caught central bankers' eyes was a 4.6 point jump in input prices to 71.0 -- fueled by a doubling of industrial metals prices in the year through May and a 50 per cent rise in crude oil prices over the same period.

"Inflation pressures remain front and center," said Hensley at JP Morgan.

Geographically, the US slowdown weighed on all the rest, with the all-industry US PMI dropping almost three points to 59.6, according to JP Morgan. Both US manufacturing and service sectors slowed in May.

But this all-industry gauge was still above the 59.0 level recorded in the euro zone last month, despite the latter being at six-year highs and up from April's 58.7.

The euro zone service-sector report, covering 2000 companies ranging from airlines to IT services and cafes, was released on Tuesday and mirrored last week's manufacturing survey by showing both input costs and prices charged rising at their fastest rate in five and a half years.

"It's all very upbeat and pretty broad-based across the region," said London-based Kevin Gaynor, head of economic and rates research at RBS, which sponsors the data.

"What is going to worry the European Central Bank in particular is the output prices numbers, which are starting to show increasing evidence that companies are generating pricing power."

- REUTERS