UK economy feels more pain

This morning’s UK manufacturing PMI survey printed a reading of 52.8 for August, its lowest level in 25 months. Before we get too carried away with ramping up project fear, it should be noted that the survey shows the sector experiencing continued growth (just as it has done since early 2013, excluding a one-off post referendum dip in July 2016). That said, a quick look at the chart below shows a disturbing trend.


UK (red) EZ (blue) and US (green) manufacturing PMI


Source: Bloomberg


Clearly the trend isn’t limited to the UK… the same applies to both the US (which has stood out on the growth front in recent years) and the Eurozone (where surprisingly, manufacturing PMI readings were the highest between H2 2017 and H1 2018). These PMI surveys are widely regarded as forward-looking indicators since they are comprised of manager’s expectations about the months ahead so while the current climate appears reasonably positive (all things considered) the outlook is more of a concern.


Looking at the UK specifically, a breakdown of the data compiled by CIPS (The Chartered Institute of Procurement and Supply) reported business optimism at a 22-month low and job creation slowing to near stagnation. Meanwhile, both input and output prices rose with companies reporting higher costs of metals, electronic components and energy which were then passed on to consumers. Unsurprisingly, the impact of a weaker pound was a contributing factor. With unemployment close to record lows but wage inflation subdued, a slowdown in job creation in the UK manufacturing sector isn’t too much of a concern (other than the desire to see a rebalancing of the UK economy).


For the Bank of England, rising prices coupled with falling demand poses a difficult dilemma. On one hand, the MPC will be eager to combat rising prices which supports the argument for higher interest rates. However, while their primary focus is on maintaining price stability, Carney and Co will not want to risk dampening the fragile signs of growth that are preventing the UK economy from slipping back into recession.


Clearly this is just a single data point so we shouldn’t get too carried away, especially when we consider that the manufacturing sector only accounts for approximately 10% of UK GDP. Nevertheless, UK interest rates look set to remain unchanged in the months ahead and we continue to see little prospect of a rate hike before the end of the year (the futures market is pricing in just a 6.6% chance of a hike before 2019). This ties in with our bearish outlook for sterling in the near term, although given market positioning and sterling’s undervaluation, we continue to believe that there is scope for a recovery in the medium term.


Attention now turns to the comparable figures from the service sector which are published on Wednesday. The consensus forecast is for a reading of 53.9, a small uptick from the previous reading of 53.5 for July. A strong number will help ease short term concerns about the health of the UK economy, but ultimately, we’ll need a significant improvement in economic data in the months ahead to give the MPC the confidence to raise rates sooner than expected.



Author: Marc Cogliatti


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