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Manufacturing activity in Canada and the US increased in August according to the latest information from the RBC purchasing managers' index (PMI) for Canada and from the Institute for Supply Management (ISM) index for the US.

Canadian August manufacturing PMI continues to rise

According to RBC Economics Research, the RBC Canadian Manufacturing PMI for August 2014 continued to trend higher for the third consecutive month, rising to 54.8 from 54.3 in July and from a recent low in May of 52.2. The PMI is calculated as a diffusion measure with any reading above 50 indicating improving business conditions in the manufacturing sector. The higher the reading is above the breakeven level of 50, the greater the pace of improvement. The August index not only points to steady improvement since May but also indicates the fastest pace of improvement since November 2013. This index had shown a previous low in January 2014 that was thought to reflect the temporary effect of the severe winter weather in both Canada and the US. The index improved modestly during the subsequent two months, although it then unexpectedly partially moved lower in April and May; however, today's data provided strong evidence that this earlier weakening trend has been reversed.

The overall PMI reflects the combined effect of five key components. In August 2014, the overall improvement resulted from gains in four of the five measures. The biggest gain was in the output index, which rose to 56.5 from 55.2 in July. The pace of increase was the fastest since November 2013 and likely resulted from earlier strong increases in new orders. The index of new orders remained robust in August at 55.3 although this was up only slightly from a reading of 55.2 in July.

The stock of purchases index returned to positive territory in August with a reading of 50.2, which was up from the 49.2 recorded in July. Manufacturing firms are seemingly continuing to take on more workers with the employment index jumping to 54.4 from 53.8 in July. This index level represents the fastest pace of hiring since September 2013. The one component that did not signal greater strength was the delivery times index. This component, which enters the overall PMI inversely, rose modestly to 45.5 from 45.2 in July. This indicates that delivery times lengthened, with an index level still below 50 but to a lesser degree relative to July.

"The continued upward trend in the August 2014 PMI is encouraging and allays concern about the faltering of the index in late spring 2014," says Paul Ferley, assistant chief economist with RBC Economics. "The strengthening trend has been most evident in Alberta and British Columbia, and Ontario. This implies rising demand for manufacturing both inside and outside of natural resources. A strengthening US economy and recent depreciation of the Canadian dollar have likely contributed to this broad-based strength and which we assume will continue to keep the overall PMI at high levels during 2015."

US manufacturing sees growth

Activity in the US manufacturing sector expanded in August 2014 at a quicker pace than the previous month as evidenced by the ISM manufacturing index rising to 59.0 from 57.1 in July. Acceleration in the gauge of manufacturing activity in August defied market expectations for a 57.0 reading and brought the headline measure to its highest level since March 2011. Any reading above the 50 level represents expanding activity.

The improvement in the headline ISM index reflected increases in three of the five main components of the measure. The new orders component jumped by 3.3 points to 66.7 to build on a 4.5 point surge to 63.4 in the previous month. The sub-component now sits at its highest level since April 2004. The gauge of current production also saw a similar-sized gain in the month, rising by 3.3 points to its highest level since May 2010, at 64.5. The pace with which firms were building up their inventories also rose in August as the "inventory change" component returned to expansionary territory, rising by 3.5 points to 52.0 after falling to 48.5 in July.

In contrast, a slightly slower pace of hiring in the manufacturing sector was evident with the employment sub-index edging lower by 0.1 points to 58.1; although, the dip followed a 5.4 jump in July that saw the measure reach its highest level since June 2011. The "supplier deliveries" index dropped to 53.9 from 54.1 in the previous month, thereby indicating that shipments from suppliers were faster than the previous month (delivery times tend to shorten as suppliers face fewer capacity constraints).

With the unexpected improvement in the headline measure in August, the ISM manufacturing index is tracking a solid 58.1 level thus far in the quarter, which is a notable improvement compared to the 55.2 recorded in the second quarter of 2014 and a weather-depressed 52.7 in the first quarter. Moreover, the spread between the "new orders" and "inventory change" components (considered to be a key indicator of future activity), while narrowing slightly (by 0.2 points to 14.7), remained elevated after surging in July and suggests that an upward trajectory in the factory sector may continue for the remainder of 2014.

This momentum in manufacturing activity should partially help offset a slower inventory build in the third quarter of 2014 following an outsized contribution in the previous quarter that reflected a payback from weather-related delays in the first quarter; however, our current monitoring suggests that softer consumer spending will likely attenuate overall GDP growth in the third quarter, which is expected to slow to 3.1% from the solid 4.2% rate recorded in the second quarter. With that said, sustained employment gains are expected to support a pace of GDP growth around 3% for the remainder of the forecast horizon.

RBC Economics

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