Following last week’s MPC meeting and the BoE decision to keep UK base rate at 5.25%, Tomasz Wieladek, chief European economist at T. Rowe Price reflects on the latest PMI data in this latest analysis commenting:
The UK economy is re-accelerating from a trough late in 2023, according to the latest PMI data. The services sector, the most important sector in the UK economy, improved from 53.4 to 54.3 – above the historical average of 53.7.
This is the fourth sequential improvement from the September low of 49.3, suggesting the significant improvements are not just one-offs due to seasonality or other technical factors, but rather that the UK economy has now entered a period of persistent and above-trend growth in the services sector.
This development has likely caught many economists, including myself, by surprise. However, most of the forward-looking survey data – including consumer confidence, housing sentiment, mortgage and unemployment data – are consistent with a broad-based and sustainable recovery in growth.
Importantly, the UK services PMI employment index rose to 51.3, which is clearly in expansionary territory. The composite PMI employment index now stands at 50.7, returning to expansionary territory for the first time in five months. The rise in the UK PMI employment index, in an environment where the unemployment rate has already been trending down, implies the UK unemployment rate will fall further.
However, the manufacturing side of the PMI implies that supply chain restrictions will raise goods prices in the coming months. Given the Bank of England’s narrative relied on disinflation in goods prices to bring overall inflation back to target, the data today challenge the idea of strong and immediate disinflation in the near term. The message from today’s PMI is that activity is reaccelerating and hiring is rising, but supply chain restrictions due to the Red Sea attacks will likely partially impede the strong disinflation expected previously.
These trends in the data will likely be exacerbated by the government’s recent changes in fiscal policy. The 2% cut in National Insurance in January will likely support the reacceleration of the economy. Furthermore, additional broad-based tax cuts will probably add further fuel to economic momentum after the Budget in March. I believe the data today, together with the government’s fiscal policy, will help the UK grow faster than the eurozone in 2024.
These data imply that the Bank of England will need to be more patient than expected. Given a falling unemployment rate, likely rising employment, accelerating economic activity, and elevated supply chain inflation risks, it is now becoming likely the Bank of England will need to wait significantly longer than expected to deliver the first rate cut. It is now likely the BoE may only be able to cut in November 2024.
Furthermore, if the data continue to be this strong and suggest persistent above-target inflation into the second half of 2024, rate hikes might come back on the table. That is, the Bank of England may have to consider hiking again to ensure inflation remains at the 2% target in the medium term. This is not a scenario markets are pricing today.
