Economists Are Beginning To Crank Up Their China Forecasts After Last Night's Manufacturing Report

flickr/Unnar Ýmir BjörnssonOvernight, the flash reading of China's August Purchasing Manager Index (PMI) indicated that the country's manufacturing sector unexpectedly stopped contracting and began expanding over the past month.

Specifically, the headline PMI index rose to 50.1 from July's 47.7 reading, beating consensus expectations for a slighter rise to 48.2 (any number below 50 on the index indicates contraction, whereas any number above 50 indicates expansion).

Following the release, BofA Merrill Lynch economist Ting Lu, who is bullish on the Chinese economy, asserted that "many Street economists will likely to revise up their overly pessimistic 3Q GDP growth forecasts soon."

Deutsche Bank economist Jun Ma did just that today.

"We revise up our H2 GDP growth forecast largely as a result of the improvement in recent indicators including today's August flash HSBC PMI report," writes Jun in a note to clients. "Specifically, we raise our Q3 GDP growth forecast to 7.7% yoy from the previous 7.5%, and raise our Q4 forecast to 7.8% from 7.7%. As a result of these changes, our H2 GDP growth is upgraded by 0.1ppt to 7.7% vs. market consensus of 7.5%."

Jun expanded on the call, linking the PMI report to the bigger picture:

The recent pickup in growth momentum, which will likely continue in our view, benefited from the following changes in the last one and half months: 1) inventory restocking, which began in late July, driven by the recovery in prices of raw materials such as steel, coal, and copper; 2) the recovery in corporate confidence due to a slew of policy announcements is beginning to boost their incentive to investment. These policies include the tax exemptions for micro firms, the setting up of the Railway Development Fund to speed up railway construction, an increase in railway investment target for this year and the likely increases for coming few years, as well as a ambitious plan to invest in environmental and energy savings projects; 3) many real estate developers are beginning to increase land purchase and launch new projects due to strong pre-sales and a more accommodative policy environment. These real estate activities will likely help push up local government revenue and in term help support infrastructure spending in the remainder of this year and next year.

Today's HSBC flash PMI report is an additional confirmation of this recovery trend. It rose sharply to 50.1 in August from 47.7 in July, and is much higher than the consensus expectation of 48.2. As the official PMI in August tends to increase by an average of 0.4pts from July due to seasonality, we believe that the official PMI for August (to be released on September 1) will likely confirm this uptrend shown by the flash report. Given that August PMI is better than July, and assuming September PMI remains at the average of July-August, it means that IP growth in Q3 will likely reach 9.7% yoy, up from 9.1% in Q2. This acceleration in IP growth should easily add 0.2ppt to yoy GDP growth in Q3, from Q2's 7.5%.

Société Générale economist Wei Yao agrees that China is on track for above-consensus growth in the third quarter following the flash PMI report.

"All major activity data are now moving in the same direction, indicating a much- strengthened growth momentum in Q3," says Wei. "a rebound in GDP growth in Q3 is almost certain and data so far point to something around 7.7% yoy."

However, Wei warns that it may not last: "We see this sudden turn-around as similar to that during Q4 2012, when the multi-quarter deceleration trend reversed shortly after the policy stance shifted to “cautious” easing. But, that growth pick-up did not last for more than one quarter. Given the on-going deleveraging of the shadow banking system and potential headwind from the external situation as a result of potential QE tapering, we caution that this uptick may not last either."