July’s preliminary PMIs out of the UK continued the theme of weaker-than-expected economic activity data out of Europe, with the eurozone measures released earlier this morning raising recession concerns on the continent.
The composite UK PMI fell from 52.8 to 50.7 to print just north of the no-change 50 level, showing the UK economy expanded at the start of Q3 but at a considerably slower rate than the first half of the year. Most of the slowdown came in services, where the PMI fell over 2 points from 53.7 to 51.5, whereas manufacturing activity remained in contraction with a reading of 45.0, 1.5 points down from June. While employment measures remained somewhat firm, the composition of the UK PMI report was generally soft, with most private sector companies citing weaker residential property market conditions and cutbacks on discretionary business and consumer spending as the main reasons for slower growth.
All in all, today’s data once again confirms that the effects of the BoE’s tightening cycle are now starting to have an impact on the real economy, and with services activity cooling specifically, this should provide further justification for the BoE to decelerate its hiking cycle with a 25bp hike in August.
With no major data releases scheduled before next week’s BoE meeting, markets are aligning with our view. Pricing of a 50bp hike has dropped following the PMI release from 47% to 34%, largely due to the softness in services output and the lowest reading in the prices charged index in nearly two-and-a-half years.
Employment conditions remain robust but the economy is feeling the effects of higher rates
The only area of continued strength within the PMI report was employment, which has shown an expansion in each of the past four releases. Even so, the measure eased relative to June, suggesting that even though firms continued to add headcount, labour demand is beginning to wane. This is consistent with the official UK labour market data, which showed a significant easing in hiring intentions and the availability of workers back in May. The continued signs of rebalancing in the UK labour market will soon become visible in headline wage growth and will be warmly welcomed by policymakers at the BoE.
However, with higher wages in the interim still providing the main source of services inflation, the Bank’s fight against tamping down inflation is far from over.
Outside of employment, the composition of July’s flash PMI report was generally soft. New orders flatlined in July, mainly due to only partial increases in services orders but a sharp decline in new business for manufacturers. This led to the backlogs of work falling the most since June 2020. Meanwhile, a further improvement in supplier delivery times resulted in lower inventory accumulation and a continued reduction in producer price inflation. This weighed on the average cost burdens for firms. While still increasing sharply, especially within the services sector due to strong wage pressures, the average measure increased at its slowest pace since February 2021. In terms of prices charged, while this once again increased on the month due primarily to services inflation on the back of higher wage costs, the rate of reported inflation eased for the fifth month in the past six.
On the whole, while there are still signs of concern for the BoE in the form of services inflation derived from a tighter labour market, the data generally confirms that the peak inflation impulse is now in the rearview mirror.
This should see the BoE step down the pace of its hiking cycle in August and for markets to continue pricing the Bank’s terminal rate lower, a dynamic that we anticipate will continue to weigh on sterling moving forward.
The pound falls slightly as traders trim BoE expectations on soft PMIs
Simon Harvey, Head of FX Analysis