UK Economy Surveys “Kibosh” Market’s Bank Rate Outlook, Pantheon Says
- Written by: James Skinner
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- Slide in UK PMI surveys warns of economic trouble ahead
- Pantheon Macroeconomics forecasts GDP contraction in Q2
- Sees rise in BoE Bank Rate cut short at 1.25% by summer
- Implies rising risk of upset for financial markets & Sterling
Image © David Holt, Accessed: Flikr, Licensing Conditions: Creative Commons
The UK economy underperformed many forecasters' expectations already during the opening quarter but the outlook for it darkened further this week and may mean the Bank of England (BoE) is more apt to disappoint financial markets in the months ahead, according to Pantheon Macroeconomics.
Tuesday’s release of S&P Global Flash PMI surveys of the manufacturing industries and the UK’s breadwinning services sector hinted of a sharp slowdown ahead for the economy and sent government borrowing costs tumbling alongside Pound Sterling.
“The collapse in the composite PMI in May is the clearest sign yet that demand is faltering in response to the intense squeeze on households’ real disposable incomes,” says Samuel Tombs, chief UK economist at Pantheon Macroeconomics.
The Purchasing Managers’ Index (PMI) for the all-important services sector came in at 51.8 for the May month, down from 58.9 previously and far below economists’ expectations for a reading of 56.9, while the manufacturing industry index also fell but by a much lesser degree.
Together the falling manufacturing and services indices pushed the composite index or overall measure of conditions in the UK’s two largest sectors down by 6.4 points, the fourth largest fall on record, which is troublesome because of the historical correlation between this number and GDP growth.
“GDP growth is slowing in most advanced economies, but the U.K. is experiencing the biggest deceleration. The Eurozone composite PMI fell only by 0.9-points to 54.9 in May,” Tombs said on Tuesday.
“Britain's underperformance reflects the sudden removal of the protection for consumers from the surge in wholesale energy prices in April, when Ofgem increased its energy price cap,” he explained.
Tombs and colleagues also cited the government’s September 2021 decision to increase employment taxes like National Insurance Contributions as a notable contributor to the fall in households’ inflation-adjusted incomes, which is the dominant burden for the services sector and overall economy.
Pantheon has also observed and warned its clients that employment levels within the services sector, which is the mainstay of the overall economy, tend to follow in the direction of the composite PMI that tumbled this month.
This is one reason why Tombs and colleagues grew more confident on Tuesday in their earlier forecast that the UK economy is likely to contract during the current quarter, which has in turn bolstered Pantheon Macroeconomics’ pre-existing expectations for Bank of England interest rate policy.
“Governor Bailey’s statement on Monday that “monetary policymakers can and must take the actions needed to return inflation to target over a period that avoids unnecessary volatility in the economy” [our emphasis] suggests that the MPC will hold back from hiking if a recession looms,” Tombs said
“Accordingly, we still expect the MPC to raise Bank Rate only by a further 25bp this year, with the further hike more likely coming in August,” he added.
This potentially sets up financial punters and Pound Sterling for disappointment as soon as the looming summer months given what is priced into the short-term interest rate markets, which still implied on Tuesday that investors and traders expect the BoE’s Bank Rate to double to 2% by year-end.
“Most MPC members likely will conclude that they do not need to be that proactive,” Pantheon’s Tombs said on Tuesday.
The BoE has raised Bank Rate a total of four times since December, taking it up from a coronavirus-induced low of 0.10% to 1% in May.
But the Bank forecast earlier in May that the economy will contract in the final quarter of the year following the next increase in the government’s ‘energy price cap,’ which would be the second of two 2022 increases that are together expected to add around £1,500 to the average household energy bill.
That was one reason why the BoE implied strongly with its other forecasts this month that there is now a high risk of a more prolonged economic contraction that would stretch into next year.
This was in turn the basis for the BoE anticipating that a currently elevated inflation rate of 9% would fall back to a level substantially below the 2% target in the coming years if the Monetary Policy Committee lifts Bank Rate in line with the market’s expectations.
“Our chart [below] shows that the composite PMI now is closer to levels seen when the MPC has cut Bank Rate than when it has increased it,” Tombs said.
Source: Pantheon Macroeconomics. Click image for more detailed inspection.