Understanding PMI: A Comprehensive Guide

The PMI is an economic indicator which assesses conditions in the manufacturing, services and construction sectors. It is considered a leading indicator for the economy - meaning it can help forecast future conditions, as opposed to lagging indicators, which indicate what has already happened. 

In this article, we will take an in-depth look at the PMI meaning, explore how it is calculated and look at the different sectors for which PMI data is reported. We will also demonstrate how PMI data is interpreted and how it can provide insight into different parts of the economy.  

What is PMI?

The Purchasing Managers Index, or PMI, is an economic indicator which assesses industry conditions in the manufacturing, construction and services sectors by collecting data from purchasing managers.

The subsequent indicator reading provides insight into current and future market conditions, and can be used to gauge which direction the economy is heading in.

The Importance of PMI in Decision Making

The information gathered from PMI data provides important insight into the future trajectory of the economy and, consequently, can aid businesses, investors and policymakers in making decisions about the future. 

• Businesses can use PMI to anticipate future levels of demand and, accordingly, adjust production, manage inventory and make strategic decisions. Their suppliers can also make similar decisions based on the same information. 
• By paying attention to the same data, traders and investors might be able to spot developing trends in the markets before they filter through to other indicators.  
• Policymakers, such as central banks, may use the PMI to help guide decisions about current economic policy. 

PMI Calculation

PMI data is collected through surveys which are sent to purchasing managers at different companies around the country.

The survey asks companies to report the change in a number of variables compared to the previous month, to which they respond whether they have risen, fallen or stayed the same. As well as these questions, companies are also asked to provide a forecast regarding output in a year’s time. 

The PMI data is reported as a diffusion index, which summarises whether market conditions are improving, deteriorating or staying the same. The diffusion index is calculated thus:

Where: 

• P1 = Percentage of respondents reporting an increase
• P2 = Percentage of respondents reporting no change
• P3 = Percentage of respondents reporting a decrease

Consequently, a score of 100 would imply that every respondent reported an increase. On the other hand, a reading of 0 would imply that every respondent had reported a decrease.

Diffusion indices are generated for every variable asked about in the monthly survey together with a headline figure which indicate the overall health of the economy.

However, publicly available reports from S&P Global, which compiles PMI data for over 40 economies including the UK, focus exclusively on a headline figure for the overall economy and headline figures in each sector for which PMI data is collected. The entire breakdown of PMI data is only available via subscription with S&P Global.

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UK PMI Sub-Indices and Headline Numbers

Originally, PMI was compiled only for the manufacturing sector. However, as economies have evolved, coverage has extended to other sectors. In the UK, S&P Global compiles and reports PMI data for the following sectors: 

• Manufacturing 
• Services 
• Construction 

The survey for each sector asks businesses to report on a number of different variables and a diffusion index is generated for every variable, which are referred to as sub-indices). For each sector, a headline figure is reported and made public.

A headline figure is also provided for the UK, which is sometimes referred to as Composite PMI and is generated using PMI data from the manufacturing and services sectors.

In the following sections, we will take a look at the three sectors listed above, highlighting the variables asked about in the surveys and explaining how the headline numbers for each sector are calculated. We will also explain how the Composite PMI is calculated. 

Manufacturing PMI

The S&P Global UK Manufacturing PMI is generated from responses to surveys sent to purchasing managers at 650 manufacturers around the country. The survey covers the following 12 variables, each of which is used to generate a diffusion index: 

• Output 
• New Orders 
• New Export Orders 
• Backlogs of Work 
• Output Prices 
• Input Prices 
• Suppliers’ Delivery Times 
• Stocks of Finished Goods 
• Quantity of Purchases 
• Stocks of Purchases 
• Employment 
• Future Output 

The headline figure is the Purchasing Managers’ Index, a weighted average of diffusion indices from five of the survey questions. Below is a list of these different indices together with their weighting in the calculation:

• New Orders (30%),
• Output (25%),
• Employment (20%), 
• Supplier’s Delivery Times (15%) and
• Stocks of Purchases (10%).

Services PMI

The S&P Global UK Services PMI is compiled from surveys which are sent to around 650 UK companies which operate in the services sector. A diffusion index is established for each variable within the survey, which are as follows:

• Business Activity 
• New Business 
• New Export Business 
• Outstanding Business 
• Prices Charged 
• Input Prices 
• Employment 
• Future Activity

The headline figure is known as the Services Business Activity Index. This is a diffusion index which is generated from the question in the survey which asks businesses to compare their volume of business activity in the reported month with the prior month. Typically, the headline figure is referred to as the UK Services PMI.

Construction PMI

The S&P Global Construction PMI is compiled from responses to surveys which are sent to around 150 construction companies in the UK. The survey asks respondents about the following variables: 

• Total Activity 
• Residential Activity 
• Commercial Activity 
• Civil Enginering Activity 
• New Orders 
• Employment 
• Quantity of Purchases 
• Supplier’s Delivery Times 
• Input Prices 
• Sub-Contractor Usage 
• Sub-Contractor Availability 
• Sub-Contractor Rates 
• Cub-Contractor Quality 
• Future Activity 

The headline figure from the Construction PMI is the Total Activity Index, which compares the total volume of construction activity in the reported month with the previous month. This headline figure is often referred to as UK Construction PMI.

Composite PMI

The headline figure of the monthly S&P Global Flash UK PMI is the Composite Output Index, sometimes referred to as the Composite PMI, which assesses the overall health of the UK economy.

The Composite Output Index is a weighted average of the Manufacturing Output Index, from the manufacturing PMI data, and the Services Business Activity Index, from the services PMI data. The weights are derived from each sector’s contribution to the UK’s GDP.

Interpretation of PMI Data

We’ve already explained how PMI data is calculated and displayed as a diffusion index, with values ranging between zero and 100. A reading of zero implies that every respondent reported worsening conditions, whilst a figure of 100 indicates every respondent reported improvement. 

The important figure to bear in mind is the mid-way point, 50. Anything above 50 implies expansion in the relevant sector. Anything below 50 indicates contraction. This easy-to-read data can give interested parties a clear and concise insight into economic conditions.

Economic Growth and Contraction

PMI is seen as a leading indicator, as it tends to reflect economic trends before they filter through to many other indicators. For example, consistent readings of above 50 in the UK composite PMI could be interpreted as a bullish signal for the UK economy. 

Conversely, whilst a PMI of below 50 doesn’t necessarily indicate that a recession is imminent, if the indicator persistently remains below 50 for a prolonged period, it could be a sign of an economic contraction. 

Traders, investors, businesses and policymakers can use this information to help make decisions.

For example, if the UK composite PMI is going through a period of consistently scoring below 50, this could be interpreted as a sign that the UK economy is entering a period of contraction.

• Traders and investors may use this information to avoid or even go short on assets with significant exposure to the UK, such as the GBP or UK-listed stocks. 
• Businesses may interpret this as a sign that demand is set to fall and adjust their output accordingly. 
• In an attempt to stimulate the economy, the Bank of England (BoE) may choose to loosen monetary policy. 

Inflation and Interest Rates 

If the PMI shows signs that the economy is overheating, central banks may look to increase interest rates to dampen demand and curb inflation. There is also other information within the PMI data which can help the BoE with inflation forecasting and to help inform monetary policy. 

For example, the sub-indices for manufacturing, services and construction contain information about input prices (i.e. the prices which businesses pay to produce goods and services). This data provides invaluable insight into the future trajectory of inflation. 

If input costs are rising for businesses, they will eventually filter through to consumers as businesses pass the higher costs onto their customers in order to preserve profit margins.  

This data may play a part in the BoE’s interest rate decisions. For example, in an inflationary environment, as long as PMI data shows that input prices are rising, in combination with other data, the BoE may interpret this as a sign that inflation will continue to rise and, subsequently, continue to hike interest rates or to maintain them at high levels. 

This can also provide a basis for traders and investors to make decisions. For example, higher interest rates are typically bullish for a currency, so any sign that interest rates are set to increase can often preempt a strengthening of the relevant currency.

Other sub-indices such as employment and new orders can also provide insight into the future trajectory of inflation and, consequently, interest rates. 

Employment

The headline figures from the PMI data can provide some insight into future employment trends.

For example, if the manufacturing PMI shows that the manufacturing sector is consistently expanding, it would stand to reason that, all else being equal, employment might begin to start trending upwards as well.

Moreover, the survey sent to businesses actually asks specifically about employment, so policymakers and other businesses can use this data to see what is happening in terms of employment in each sector from month to month. 

Conclusion

PMI data can be an advantageous tool for a variety of people. Its regular releases, easy-to-interpret data and ability to potentially provide insight into future economic trends can potentially help investors, businesses and policymakers make decisions ahead of the curve. 

Furthermore, for those that are able to look beyond the headline numbers, the full array of sub-indices compiled by S&P Global can provide an in-depth picture into the health of the manufacturing, services and construction sectors in the UK, as well as that of the wider UK economy itself. 

However, it’s important to never rely too much on any one indicator. Whilst PMI data can provide a lot of insight into the economy, it does not provide a fully comprehensive picture. Traders, investors and other observers should look beyond PMI and use its data in conjunction with other information before making important decisions. 

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