Service PMI Miss Heaps Woe on Sterling

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- Sterling under pressure in mid-week trade

- Service PMI reading suggests economy shrank in 2nd half

- But economy to avoid recession says Pantheon Macroeconomics

The British Pound was seen under selling pressure in mid-week trade after the release of data that showed the UK's dominant services sector struggled in June.

The IHS Markit Services PMI read at 50.2, down on the previous month's 51.0 and below market expectations for a reading of 51.0.

The disappointment comes in the wake of poor Construction and Manufacturing PMI releases; all results point to a rapid slowdown in UK economic growth in the mid-year period.

The outcome ensures the British Pound remains under selling pressure: the Pound-to-Dollar exchange rate is quoted at 1.2569. The Pound-to-Euro exchange rate is quoted at 1.1139 at the time of writing, and looks intent on testing the multi-month low set at 1.1122 just last week.

"The near-stagnation of the services sector in June is one of the worst performances seen over the past decade and comes on the heels of steep declines in both manufacturing and construction," says Chris Williamson, Chief Business Economist at IHS Markit.

The survey shows a lack of new work to replace completed projects contributed to a decline in unfinished business for the ninth consecutive month.

"The fact that new orders have ground to a halt in the service sector suggests that underlying economic momentum is unlikely to increase imminently," says James Smith, Developed Markets Economist with ING Bank in London. "Attention within firms will also be increasingly turning back to contingency planning for a possible ‘no deal’ Brexit in October, which is often a costly exercise and will inevitably draw some resources away from possible investment projects."

The current period of falling backlogs of work is the longest recorded since 2011/12.

Employment growth does however remain a bright spot in the report. Despite signs of spare capacity, service providers signalled a solid expansion of employment levels in June.

Jobs growth has been recorded in three of the past four months, with survey respondents often linking staff recruitment to long-term business expansion plans.

When all three PMIs - construction, manufacturing, services - are weighed up to give a broader assessment of the economy, IHS Markit data suggests the UK's private sector output declined for the first time in almost three years.

"The June reading rounds off a second quarter for which the surveys point to a 0.1% contraction of GDP," says Williamson.

While the UK economy appears to certainly be experiencing a soft patch, we are told by one economist that it would be wrong to assume the UK is heading for recession.

"A weighted average of the three PMIs points to a 0.1% quarter-on-quarter drop in GDP in Q2, which is plausible, given the drag from the unwind of Q1’s stockpiling boost. It would be a mistake, however, to expect GDP growth to remain near-zero in the second half of this year," says Samuel Tombs, UK Economist with Pantheon Macroeconomics. "Growth in households’ real incomes looks set to pick up, as the recent fall in energy prices pushes CPI inflation below the 2% target and job growth remains strong."

Furthermore, services firms reported in June that employment rose at the fastest rate since August 2017 and optimism among services firms about the outlook for activity in the year ahead also remained above its 12-month average in June, despite falling marginally.

Tombs adds that growth in government spending is set to remain relatively strong; the OBR expects year-over-year growth in real government spending to pick up to 2.1% this year, from 0.2% in 2018.

"It isn’t all bad news," says Andrew Wishart, UK Economist at Capital Economics. "Some of the other balances of the services PMI improved. The backlogs of work and employment balances of the survey, which are historically the best guides to how the services sector will fare over the next few months, ticked up to an eight- and 22-month high respectively!"

Wishart cites the composite employment PMI rising to its highest level in over a year as further grounds for optimism, "so the dip in activity does not appear to be translating into a weaker labour market."

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