Manufacturing activity showed its usual expansion in August from July as new orders increased for the second month in a row, the latest BNZ Capital-Business NZ Performance of Manufacturing Index (PMI) shows.

However, seasonal adjustment indicated further contraction in the sector from July, with BNZ economist Craig Ebert saying the slight slip was "a timely note of caution". Manufacturing activity generally expands between the two months, barring 2008 when the sector was in contraction.

Unadjusted figures show an expansionary PMI score of 50.2 in August, from a contractionary 49.4 in July. A level above 50 indicates expansion in the sector, while a level below 50 indicates the sector is in contraction. The Index's 'new orders' sub-group led the way with expansion from July, although at a slightly slower pace than July's expansion from June.

Seasonally adjusted, the PMI was 48.7 in August, indicating the jump between the two months was weaker than in previous years. It fell from 49.6 in July, indicating the pace of contraction quickened again in August after it had generally improved over the year. August was the sixteenth consecutive month of contraction for the sector.

Ebert said BNZ maintained its view that a mild economic expansion would be emerging around about now, for manufacturing as much as the economy at large. "But we also continue to counsel that folk should be taking things one step at a time, rather than taking a running jump with their expectations," he said.

While the shape of the recovery remains uncertain there is little doubt about the depth of the hole needed to be climbed out of in order to restore "normality". In respect to Tuesday's manufacturing survey, we reckon it implied a further 3.0% drop in production in the June quarter. This, in turn, infers a 16% contraction from a year ago. That's twice as bad as the previous worst annual decline of 7.5% back in the early 1990s.

To be fair, this downfall has come amid the worst global economic performance in many a decade and more so in respect to trade and manufacturing. In this respect, New Zealand can be especially thankful it's not a producer of vehicles.

We also note that some of the damage to the NZ results has been accentuated by a fall-off in aluminium production from the country's Tiwai Point smelter. Yes, there were signs, via export volumes, that ingot extrusion stepped up in Q2. Nevertheless, it looks far from fully recovered from the sharp downscaling that occurred over September through March, partly related to a bung pot that few seemed in a rush to restore at the time, given very low aluminium prices.

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However, the excuses run only so far. It's also worth bearing in mind the local manufacturing slump of the last twelve months traversed a sizable rebound in dairy production (following the severe drought the previous year) that would normally have been enough for manufacturing output to expand, overall.

And the overall contraction we judge for the June quarter of 2009, in particular, was all the more disappointing in that it came despite signs that meat processing increased, aluminium production improved and forestry activity bounced back on buoyant exports, albeit mainly logs to China.

This implies the rest of NZ manufacturing must have remained very poorly indeed, up to June. This highlights the plight of the manufacture of investment-type goods, such as plant, machinery and equipment, electronic goods and other elaborately transformed manufactures.

And this might well remain an area of vulnerability given that investment spending "“ here and abroad "“ will likely be one of the last areas to join the recovery bandwagon, considering the extent and duration of spare capacity to bedevil the process yet. We would very much include Australia "“ still New Zealand's biggest market for manufactured goods "“ in this equation. Its capex outlook remains cloudy, with some business investment already brought forward on account of increased depreciation allowances, and investment to GDP ratios relatively high for this point in the cycle.