UK Economy Seen at Stall Speed Again in First-quarter after Services PMI Shock

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- IHS Markit PMI surveys suggest UK economy stalled in first-quarter.

- But the surveys are poor indicators when political uncertainty is high.

- Economists stick with forecasts for Q1 growth between 0.2% and 0.3%.

The UK economy is likely to have stalled in the first quarter if Wednesday's IHS Markit services PMI is anything to go by, according to Capital Economics, as the sharp slowdown observed in the UK's largest economic sector means GDP growth will also have suffered.

The IHS Markit services PMI fell to 48.9 in March, from 51.3 previously, when markets had looked for a decline to only 51.0. The result covers a month in which uncertainty about the UK's path out of the European Union reached a crescendo. 

Markets spent much of March attempting to anticipate whether the UK would 'crash out' of the EU at the end of the month given Prime Minister Theresa May failed on two occassions to pass her EU Withdrawal Agreement through the House of Commons that month.

As a result, activity saw a "marginal reduction" in March that brought to an end more than two and half years of expansion. Meanwhile, new orders fell for a third consecutive month after clients were said to have delayed spending decisions given "intense political uncertainty", which bodes ill for the outlook. 

"At this level, the headline PMI is consistent with services sector output contracting at a quarterly rate of around -0.1%, compared to Q4’s 0.5% rise. That would be the worst quarterly rate since Q4 2012," says Ruth Gregory of Capital Economics. 

Above: UK services PMI activity index. Source: IHS Markit. 

PMI surveys measure changes in industry activity by asking respondents to rate conditions for new orders, production, hiring intentions, prices and inventories. A number above 50.0 indicates industry expansion while a number below 50 is suggestive of contraction. 

Markets care about the PMIs because, covering the UK's three largest sectors, they are an important indicator of momentum within the economy. And rising demand within an economy can lead to inflation, which is what the Bank of England (BoE) is attempting to manipulate when it tinkers with interest rates. 

Gregory says Wednesday's survey means the economy will have, at best, stagnated in the first quarter of the year. Although that's only if the signals sent by the survey are accurate this month, and there are some grounds to think they might not be. 

"The PMIs were too downbeat in the fourth quarter so it would not be a surprise if GDP surpassed the rate predicted by the surveys again in Q1. The qualitative nature of the survey questions means that sentiment can creep in. And the service sector PMI does not cover the retail sector and retail sales have been robust since the start of the year," Gregory explains, in a note to clients. 

Capital Economics still forecasts first-quarter GDP growth of 0.3%, although Gregory said Wednesday there are now "downside risks" to that projection.

All IHS Markit PMI surveys slumped sharply in January, prompting headlines claiming the economy was at "stall speed" early in the New Year although Office for National Statistics data later revealed the economy grew by 0.5% in that month alone. 

A similar thing happened immediately after the EU referendum of 2016, which prompted IHS Markit PMIs to indicate the economy was close to a recession in the third quarter of that year. ONS data later showed that, in fact, the economy grew by 0.6% that quarter. 

Above: All-sector PMI correlation with UK real GDP growth. Source: Pantheon Macroeconomics.

"The weighted-average of the three PMIs in Q1 points to quarter-on-quarter GDP growth slowing to about zero... But note that the PMIs have tended to be too downbeat in the past when economic uncertainty has been high," says Samuel Tombs, chief UK economist at Pantheon Macroeconomics. "We continue to expect GDP to rise in Q1 at a similar pace to Q4."

Tombs, who is ranked by Bloomberg and Reuters as the top economic forecaster for the UK, has been projecting GDP growth of 0.3% for the first quarter. However, Wednesday's comments suggest he might now believe growth could be somewhere between the 0.2% seen at the end of 2018 and his 0.3% forecast.

Nonetheless, the surveys point clearly toward at least a slowdown in growth and will serve to keep markets guessing about the likely health of the economy for a while yet. First quarter GDP data is due out on May 10.

Meanwhile, Prime Minister Theresa May is set to enter talks with opposition leader Jeremy Corbyn in an attempt to secure parliamentary support for an agreement that will prevent the UK from making a clean break with the EU, and potentially leave trade policies and some aspects of lawmaking in EU hands. 

The PM said Tuesday she will seek from the EU a longer extension to the Article 50 exit negotiating window to that end. Currently, April 12 marks an EU deadline for May to choose between requesting a much longer extension of the Article 50 negotiating window that would certainly require participation in the EU parliament elections, or a so-called no deal Brexit.

Uncertainty over the future relationship with the EU that has been the most prominent concern for economists and the Bank of England. The bank has said repeatedly in recent months that it would like to lift interest rates, citing a strong labour market and wage growth that risks stoking an already-elevated consumer price index. 

However, it's thought to be reluctant to pull the trigger on rate hikes until it can be confident a disorderly EU exit will be avoided. Financial markets have recently begun speculating there is a chance the BoE could be forced to cut interest rates before the year is out. 

The overnight-index-swap-implied Bank Rate for December 19, 2019 was just 0.67% on Monday, beneath the current 0.75%.


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