Services sector growth slows at start of 2018 to throw doubt on outlook

Growth from the UK's key services sector slowed at the start of the year, a survey on Monday showed, offering a contrasting message on economic growth after a prominent thinktank upgraded its forecast for gross domestic product.

January's purchasing managers' index from IHS Markit/CIPS fell to 53.0 from 54.2 the month before, worse than the minimal decline to 54.1 that the market expected and a 16-month services sector low.

A fall in the services PMI meant that all three of January's surveys had indicated a slowdown in growth and saw Markit's composite PMI slide to 53.5 from 54.9 in December and also below the 54.6 consensus estimate.

This points to quarterly GDP growth of about 0.3%, much lower than the 0.5% outturn from the fourth quarter of last year.

Earlier on Monday, the EY Item Club thinktank, which uses the Treasury’s economic model, lifted its 2018 forecasts for UK growth to 1.7% from its previous 1.4% as it felt the economy is “over the worst”. It also expected the Bank of England to increase rates twice this year as it moves “towards normalising monetary policy”.

Markit's services survey found firms reporting a loss of existing clients and "lingering concerns surrounding the UK’s exit from the EU", though new business increased at a slightly quicker pace, which was attributed to successful marketing campaigns and the new service offerings.

Forward looking indicators were mixed, with inflows of new business showing the smallest monthly rise since August 2016, suggesting output growth could weaken further in February. However, expectations about companies’ business activity levels in a year’s time struck a ten-month high amid brighter outlooks in all three sectors, while the balance of services firms expecting activity to increase over the next 12 months rose to its highest level since March.

The survey revealed an easing of inflationary pressures, with the balance of prices charged fell to a four-month low, lifting concerns over domestically-generated inflation.

Demand for transport and communication services also fell for a third straight month, with the most resilient performance recorded in financial services.

Service sector expansion weakening to a 16-month low reflected a marked waning of growth in demand for business services and falling inflows of new work in consumer-facing sectors such as hotels and restaurants, said IHS chief business economist Chris Williamson.

"The January decline pushes the all-sector PMI down into dovish territory as far as Bank of England monetary policy is concerned, historically consistent with a loosening bias. As such, the data cast doubts on any imminent rise in interest rates. Since 1999, interest rates have not been raised when the all-sector PMI has been below 56.5, with the sole exception of last November’s hike to 0.5%," he said.

Economist Samuel Tombs at Pantheon Macroeconomics also felt the report "should prompt investors to reassess their view that the chance of the MPC raising interest rates again as soon as May is as high as 50%" and that the PMIs data could be enough to "strengthen the case for the MPC to take a lengthy pause before raising interest rates again". He forecast the next hike will come in August.

Paul Hollingsworth at Capital Economics said the weak survey "may not necessarily be a sign of things to come", taking optimism from the pick-up in new orders and the future activity readings

Noting that both the input and output prices index in the survey fell, he said a fall in inflation this year, consumer services firms in particular should benefit from an improving backdrop for household spending.

"As a result, today’s survey does little to alter our view that the consensus for GDP growth of 1.4% this year is too downbeat."

Howard Archer, chief economic adviser to the EY Item Club, while seeing the near-term prospects for the UK economy as appear "brighter", helped by the squeeze on consumers easing as the year progresses, he saw Britain remaining “stuck in the middle lane” over the medium term, growing by 1.7% in 2019 and 1.9% in 2020, weaker than neigh neighbours in the euro area.

“It’s not time to crack open the champagne just yet,” Archer said. “Brexit uncertainties remain significant, while the squeeze on consumers remains appreciable at the start of 2018.”