Sterling and yields strengthen on UK PMI numbers

Strong PMI numbers from the UK which, despite all the fretting about the risk of the UK slipping into recession, suggest the economic outlook remains bright. The composite index rose from 52.1 in December to 52.5 in January, to sit above the key 50.0 level for the third month in a row and pointing to the strongest rate of growth in overall output since June last year. Much of this strong performance was accounted for by the services sector, where today’s reading rose to 53.8 (52.3 in December) to register the fastest pace of growth since May 2023. In contrast, manufacturing activity continued to contract, printing at 47.3 and remaining in contractionary territory for the eighteenth month in a row. But overall the survey implies that the UK economy started 2024 in a stronger position than it ended 2023 and suggests that, even if the official Q4 GDP figures ultimately confirm that the UK slipped into a technical recession in H2 2023, such a scenario should be short lived, today’s report suggesting a Q1 growth rate of approximately 0.2% (although the PMI survey is not a particularly reliable predictor of GDP).

Further evidence of strengthening activity is found with the recording of a modest increase in employment growth, respondents reporting both improving demand conditions and a more optimistic outlook as providing the backbones of this pick-up in demand for labour. However, on the downside, the disruptions being seen in Red Sea shipping routes are starting to be felt, with input costs said to be rising at their fastest pace since August last year and delivery times lengthening for the first time in a year, and to the greatest extent since September 2022. The culmination of both of these pressures saw factory gate prices rise at their fastest pace since March 2023.

But despite the better growth message, the report potentially makes it harder for the Bank of England (BoE) to cut interest rates as soon as the market is expecting. Robust growth and strengthening price pressures are not a scenario the BoE will want to be loosening policy into, particularly given that the supply chain disruptions being seen are increasingly looking as if they will be sustained for some time. With factory prices rising at the same time as pricing pressures remain elevated – particularly in the services sector – the task facing the BoE in bringing CPI back to its 2% target is potentially looking more difficult, and facing the risk that CPI remains stubbornly entrenched around the 3.5%-4.5% level. Given all the data currently available to the BoE, on balance the inflationary outlook is probably still sufficiently benign to allow it to begin cutting interest rates this year, albeit possibly less than the market has been expecting. But this scenario could easily change if today's PMI report is a harbinger of developments to come.

The markets have already responded to this risk with sterling strengthening and gilts giving up early gains, 2-yr yields rising by around 6bps; both sterling and yields can be expected to rise further if a view of the BoE being in no hurry to cut rates starts to become entrenched.