UK Services Sector Returned to Growth in April but Economists say PMI Surveys are Underestimating the Expansion

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- UK services sector returns to growth in April, IHS Markit says.

- Data offers hope of positive start to Q2 for the UK economy.

- Economists say IHS surveys underestimating the expansion.

The UK services sector returned to growth last month as activity among companies in the UK's largest economic sector recovered from an earlier trough, according to the latest IHS Markit PMI survey, although it will be a tall order for the economy to better its first-quarter performance. 

The UK services PMI rose from 48.9 to 50.4 during April, in line with the market consensus, as the UK's economic engine crossed the rubicon that marks the difference between output growth and contraction. 

However, and on the downside, IHS Markit says demand for services remained subdued early in the second quarter with new work orders falling for a fourth consecutive month. Hiring intentions also softened amid an uncertain outlook for demand and rising wage costs. 

"The headline PMI is still consistent with flat services sector output in Q1 and Q2 compared to Q4’s 0.5% q/q rise. That would be the worst quarterly rate since Q4 2012. The small rise in the services PMI more than offset the drop in the manufacturing PMI, as a result the all-sector PMI rose from 50.0 to 50.9, but this still suggests that GDP in Q2 rose by just 0.0–0.1%," says Thomas Pugh, an economist at Capital Economics. 

PMI surveys measure changes in industry activity by asking respondents to rate conditions for employment, production, new orders, prices, deliveries and inventories. A number above the 50.0 level indicates industry expansion while a number below is consistent with contraction.

Markets care about the data because it is an important indicator of momentum within the economy. And economic growth has direct bearing on consumer price pressures, which dictate where interest rates will go next.

"We think that the PMIs are being too downbeat and so are of limited value at the minute. Indeed, we suspect that GDP growth was 0.5% in Q1 rather than flat as indicated by the all-sector PMI. Nonetheless, we still think that as some activity was probably brought forward ahead of the original Brexit deadline, GDP growth in Q2 is likely to be weaker than in Q1," Pugh says. 

IHS Markit PMI surveys have since December 2018, frequently pointed to a flatlinging, if not contracting, economy. Those readings came amid farcical calamity in parliament over the UK's pending exit from the EU and as fears of a possible 'no deal Brexit' were wratcheting up. 

However, official statistics show that UK economic output rose by a total of 0.7% in the first two months of 2019, even faster than the 0.6% pace of growth seen through all of the third quarter 2018, which put the economy on course for its best quarter since the period spanning April to July 2015.

Meanwhile, the UK unemployment rate has fallen to a new post-1973 low of 3.9% and wages are growing at their fastest pace in nominal terms since before the financial crisis. 

"The Markit/CIPS services survey continues to suggest that the economy has no momentum," says Samuel Tombs, chief UK economist at Pantheon Macroeconomics. "The PMIs, however, also pointed to stagnation in Q1; data next week likely will show that GDP increased by a solid 0.5%. We suspect that the PMIs still are overstating the extent to which Brexit uncertainty is dampening economic activity. Note too that the PMIs don’t cover the retail or public sectors."

The Bank of England upgraded its forecast for UK GDP growth in 2019 on Thursday, lifting it from 1.2% to 1.5% before reiterating its commitment to raising interest rates over the coming years in order to safeguard its 2% inflation target.

UK growth has been resilient during recent quarters even in spite of the Brexit process and a broad global economic slowdown playing out in the background, although most of the heavy lifting has been done by households and consumers. 

"We agree wholeheartedly with the MPC’s conclusion this week that "less weight than usual should be placed on the steer from surveys when forming near-term growth projections.” We continue to expect GDP growth to slow to 0.2% in Q2, with a pullback in manufacturing output accounting for the bulk of the slowdown and the services sector still growing at a steady rate," Tombs concludes.

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