Eurozone manufacturing returned to modest expansion in August after more than three years of weakness, while much of Asia’s export-led industry continued to contract — a divergence driven less by a single shock than by a mix of stronger domestic demand in Europe, cyclical inventory adjustments, and the growing bite of U.S. trade barriers and realigned supply chains. The contrast is forcing manufacturers, policymakers and investors to rethink where growth will come from in the next year.

European factories, led by pockets of strength in southern and peripheral economies, are finally benefitting from a pickup in local orders and easing inventories. The HCOB Eurozone Manufacturing PMI rose above the 50 threshold in August, signalling expansion after a prolonged period of stagnation. The recovery is uneven — Germany’s headline reading remained just below growth territory — but the broader region is showing healthier momentum in output and new orders than at any point since early 2022. That improvement reflects stronger household spending on goods, restocking after prolonged underinvestment, and a rotation in demand toward locally produced equipment and components as firms shorten supply chains.

Northern and peripheral markets have been important contributors. Countries including Spain and Greece posted the sharpest manufacturing rebounds in the month, where domestic construction and a rebound in services-linked demand for goods have helped buoy factory activity. Even in Germany, where manufacturing continues to face headwinds from weaker external demand, firms reported rising production and a third consecutive month of expanded new orders — an early signal that a recovery may spread into Europe’s heavy industrial core if global orders stabilise.

Tariffs, trade frictions and a new calculus for supply chains

One of the most potent external forces reshaping the picture is the surge in trade barriers and tariff unpredictability emanating from Washington. The recent wave of steep U.S. import duties has curtailed several Asia-focused export streams and accelerated a reshuffling of global supply chains. Asia’s export champions — Japan, South Korea and Taiwan — recorded contracting manufacturing activity in August, with firms citing softer export orders to the United States and Europe as a core reason. For many producers in those economies, access to the U.S. market is a linchpin: when duties spike or trade policy becomes uncertain, orders are deferred or routed elsewhere.

That said, the tariff story is complex. In some cases, temporary exemptions or bilateral deals have mitigated immediate losses for targeted goods. In others, legal challenges and implementation delays have created ambiguity that is itself harmful to exporters that depend on stable, multi-quarter planning horizons. The net result has been a significant headwind for Asia’s export-oriented manufacturers at the same time Europe has seen demand come back from domestic sources.

China bucked the regional downtrend in August, with private-sector surveys signalling a modest expansion in factory activity. That uptick — while real — is shaped by a different set of drivers: selective stimulus measures, inventory rebalancing in some commodity-heavy supply chains, and domestic policy support for key industrial segments. For the wider region, however, the picture remains more mixed: economies that rely heavily on U.S.-bound shipments or that produce goods exposed to steep new tariffs saw the most significant contractions.

Product cycles, inventories and the rhythm of restocking

A second, less sensational but equally important driver of Europe’s return to growth is the inventory cycle. After months of cautious ordering and deliberately lean stock levels, many European manufacturers are now topping up inventories to avoid shortages that disrupted production last year. That restocking process raises production even in the absence of a large jump in final consumption, and it amplifies any uptick in domestic demand. In short, a combination of higher household spending on durables and managers’ desire to avoid repeat stockouts has produced a meaningful but still-fragile rebound.

Asia’s factories, by contrast, remain caught between slowing external demand and elevated capacity in several sectors. Producers of components, semiconductors and intermediate goods have seen orders from global clients decline or shift to rival suppliers. Added to that is intensified competition from lower-cost Chinese manufacturers in some segments, which has compressed margins for supplier nations in East Asia and made capacity utilisation weaker across a range of industries.

Policy, pricing and the geography of demand

Fiscal and monetary settings are also playing a role. Several European governments have used targeted support for green investment and industrial upgrades, while central banks in parts of the region are signalling the easing of some restrictive measures as inflation cools — a pairing that has helped restore business confidence in headline numbers. In Asia, by contrast, growth has been more uneven: nations such as India are registering robust domestic demand and high manufacturing expansion, while export-reliant economies are struggling with tariff exposure and a slowdown in overseas orders.

The direct effect of U.S. tariffs on these dynamics is tangible but not uniform. For products directly subject to duties — from parts and components to certain consumer categories — firms in Asia are already feeling the cost and competitiveness squeeze. In some cases exporters have pivoted production away from the United States or sought tariff-exempt channels; in other instances, trade diversion has benefited producers in countries not targeted by tariffs. This re-routing of trade flows is helping explain why Europe, which is less immediately exposed to the current tranche of U.S. duties and is seeing stronger domestic momentum, can register expansion even as Asia’s export volumes slide.

Manufacturers are responding with a mix of tactical and strategic moves. Short-term, many firms are reallocating production to facilities closer to final demand, shortening lead-times and raising inventory buffers to avoid disruption. Medium-term strategies include diversifying supplier bases away from tariff-sensitive routes, investing in automation to reduce sensitivity to labour-cost differentials, and accelerating the rollout of product lines tailored to local consumption patterns.

The near-term outlook hinges on three variables: the persistence of domestic demand in Europe, the extent and duration of U.S. tariff measures and legal rulings that could alter or roll back duties, and how quickly Asian exporters can adapt by reorienting supply chains or moving up the value chain. If tariffs remain in place or widen, Asia’s export sectors could face prolonged pressure; conversely, if trade tensions ease or investment shifts boost domestic markets in Asia, the current divergence could narrow.

European firms will also be closely watching whether the recent PMI gains translate into sustained order inflows and higher utilisation — because inventory-led rebounds can reverse quickly if final demand weakens. For policymakers, the test will be balancing support for domestic industrial resilience while managing the fallout of a realigned global trade architecture.

(Adapted from MarketScreener.com)

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