- UK composite PMI: 53.9 vs 54.6 expected
- UK manufacturing PMI: 46.9 vs 48.0 expected
- UK services PMI: 55.1 vs 55.3 expected
Since the turn of the year markets have been surprised by the robustness of the UK economy, a trend that took off following the publication of February’s flash PMIs.
This pattern was repeated once again in today’s release, with the composite PMI printing at 53.9, which whilst lower than April’s level of 54.9 still indicates a growing private sector. However, as seen in eurozone figures earlier this morning, this robust headline number hides a large and growing divergence between the fortunes of the services and manufacturing sectors. The UK’s manufacturing PMI continued a pattern of recent weakness, with the services sector once again stealing the show. For the Bank of England, it is the latter of these that is most important and not just because services produce the overwhelming majority of UK economic output. The strength of services inflation and the passthrough of wage increases has been a key concern for policymakers in recent months. Today’s report shows the evolution of these factors progressing in line with recent BoE forecasts, alongside signs that labour market conditions are beginning to ease. If confirmed in the next round of hard data, this should set the scene for a pause in rate hikes in June.
The strength of the UK services sector has been the key driving force keeping the UK economy out of recession in recent months, but this has come at the cost of a strong labour market and robustness in wage growth.
This was reflected once again in this latest report, noting that while input price inflation eased marginally this was concentrated amongst good producers as a result of falling energy bills and raw materials prices. Strong wage inflation, in contrast, saw service providers experiencing the fastest rise in cost burdens for three months. Despite this, businesses reported that overall cost pressures were now the least severe since March 2021. This was further reflected in output charges, which whilst continuing to grow at a historically fast pace, is now showing the second-lowest rate of growth since August 2021. Given that the Bank of England currently expects services inflation to peak this month at 6.7% YoY, these signs will be encouraging. Importantly they indicate that whilst still robust, inflationary pressures are not snowballing and there is little apparent evidence of a greed-flationary dynamic.
Even more reassuring will be evidence on that state of labour market, where there is now building evidence of slowdown.
Crucially, today’s report noted that whilst private sector employment did increase, this was marginal and at a far slower rate than that seen over the course of 2022. This compounds the evidence from both the REC report on jobs and recent hard data for March and April, which indicated that whilst wage pressure remained robust, employment conditions are beginning to slow markedly. The REC survey in particular suggests that staff availability is improving, with divergent recruitment trends leading to permanent placements continuing to fall, but offset with rising temporary employment. This is consistent with the observation that candidate availability has now improved, which alongside rising business requirements drove the uptick in employment in May. With the supply of labour improving and firms’ employment demand starting to cool, this can reasonably be expected to translate in slowing wage growth over coming months – a dynamic that we’re already seeing momentum in when analysing nearer term metrics of wage growth. Given signs increasingly showing up across a broad range of measures that core inflation should begin to turn over in line with Bank of England forecasts, and headline CPI inflation due to fall rapidly in April, we think the BoE will likely be able to pause hiking rates if this dynamic is confirmed in hard data before the June meeting. Whilst risks remain to the upside with a chance that it takes a little longer for this story to play out, it is now a matter of if not when, and in our view today’s release confirms that an upside surprise would be necessary to shift the bias in favour of further monetary tightening.
Nick Rees, FX Market Analyst