Markets overprice scope for rate cuts amid UK private sector recovery

(Alliance News) - The UK's private sector expansion was stronger than anticipated at the start of 2024, preliminary data suggested on Wednesday, although the Red Sea crisis is showing early signs of reigniting inflationary pressures.

Meanwhile, Pantheon Macroeconomics said that markets are likely "slightly overestimating" the scope for rate cuts from the Bank of England's Monetary Policy Committee.

The S&P Global flash composite purchasing managers' index rose to a seven-month high of 52.5 points in January, from 52.1 in December. Rising further about the 50-point no-change mark, it shows the pace of expansion sped up slightly. The reading was higher than FXStreet-cited market consensus of 52.2.

The expansion was solely down to growth within the services sector, as the services flash PMI rose to an eight-month high of 53.8 from 53.4, and came above FXStreet-cited market consensus of 53.2.

Manufacturing remained in sub-50 contraction territory with a flash PMI of 47.3, though the reading was nine-month high, and above 46.2 the prior month. However, production fell at the fastest pace since last October, amid weak order books and overstocked customers.

"The latest survey also indicated a return of modest private sector employment growth at the start of 2024, supported by improving demand conditions and higher levels of optimism towards the business outlook," S&P Global said.

However, private sector firms saw the sharpest rise in input costs since last August, led by cost pressures within UK factories. Firms often remarked on higher freight costs stemming from the Red Sea crisis, while associated shipping delays caused suppliers' delivery times to extend for the first time in a year. It was also the greatest rise in delivery times since September 2022.

Service providers also noted a steep rise in input costs, stemming from rising wages. However, the rise was the weakest in three months, leading to a softer rise in output pricing. Overall, prices increased at the weakest pace since last October.

"The survey data point to the economy growing at a quarterly rate of 0.2% after a flat fourth quarter, therefore skirting recession and showing signs of renewed momentum," said Chris Williamson, chief business economist at S&P Global Market Intelligence.

"Businesses have also become more optimistic about the year ahead, with confidence rebounding to its highest since last May. Business activity and confidence are being in part driven by hopes of faster economic growth in 2024, in turn linked to the prospect of falling inflation and commensurately lower interest rates," he added.

Pantheon Macroeconomics concurred that the latest PMI read suggests that the UK economy is "quickly escaping the mild recession that it went into in the second half" of 2023.

However, the research house expressed caution that, while the PMI data remain consistent with the MPC being able to cut interest rates this year, it will be at a more gradual pace than investors currently expect.

"The MPC can let this recovery take hold if it thinks that it won't cause the labour market to tighten or the headline rate of [consumer price inflation] inflation to start rising again, once it likely has returned to the 2% target this spring. The evidence from the PMI survey is mixed," said Pantheon Macroeconomics analyst Gabriella Dickens.

Pantheon Macroeconomics noted the composite employment index rising to 51.0 in January from a contractionary 49.1 in December, which it said was consistent with the PAYE Real-Time Information measure of employee numbers rising by 0.2% on a three-month-on-three-month basis.

"That is probably consistent with a flat unemployment rate, assuming that the workforce continues to grow briskly, supported by immigration. In addition, the prices charged index of the services survey edged down to 57.3 in January, from 58.6 in December, consistent with month-to-month annualised growth in the services CPI, on a seasonally adjusted basis, of around 4.0%. That's far lower than the average across 2023, 6.3%, but still some way above the near-3% rate likely required for the headline rate of CPI inflation to remain near the 2% target indefinitely," said Pantheon Macroeconomics' Dickens.

"All told, then, the PMI data remain consistent with the MPC being able to cut interest rates this year, but at a more gradual pace than investors currently expect. We still look for a 75 [basis point] reduction in bank rate this year, slightly less than the 100 [basis point] implied by [overnight index swap] rates."

S&P Global Market Intelligence's Williamson himself recognised that January's more-robust-than-expected growth could deter the BoE from cutting interest rates as soon as many are expecting.

Williamson noted the BoE will also be paying attention to the inflationary pressures stemming from the Red Sea crisis.

"The longer journey times lifting factory costs at a time of still-elevated price pressures in the service sector. Inflation is therefore indicated to remain stubbornly higher in the 3-4% range in the near future," Williamson concluded.

On Wednesday last week, data from the Office of National Statistics showed UK consumer prices unexpectedly heated up in December.

The ONS said the consumer price index rose by 4.0% annually in December, the pace of inflation notching up from a 3.9% increase in November. The reading came in hotter than market expectations, with consensus having been for price inflation to cool to 3.8%, according to FXstreet.

Inflation's recent peak was 11.1% annually in October 2022, which the ONS estimates to be the highest since 1981.

Last month, the BoE kept its bank rate at a 15-year high of 5.25%. It is the third successive hold, following one in September, which ended a streak of 14 consecutive hikes since December 2021, and one in November. The BoE had rapidly increased bank rate from a Covid-19-induced low of 0.10%.

The BoE's MPC will make its next interest decision on Thursday next week.

The flash PMIs are compiled by S&P Global from responses to surveys sent out to around 650 manufacturers and 650 service providers in the UK. Responses are collected in the second half of the month.

By Greg Rosenvinge, Alliance News senior reporter

Comments and questions to [email protected]

Copyright 2024 Alliance News Ltd. All Rights Reserved.