UK services growth weakens, business optimism evaporates

Growth in the UK's services sector weakened to its lowest in four months in June, according to a Markit survey published on Wednesday that also found business optimism dropped to its second-lowest in over five and half years.

The UK Markit/CIPS services purchasing managers' index for June fell to 53.4 from the prior month's 53.8 and shy of the consensus forecast of 53.5.

Following disappointing PMIs for the manufacturing and construction sectors earlier in the week it meant the UK composite PMI for June dropped to 53.8 from 54.3 and below the market's expectation of 53.9.

Levels of business optimism also declined to the weakest since December 2011, Markit revealed, save for the post-referendum dip last summer, while new orders increased at the slowest rate for nine months.

With the services sector representing more than three quarters of the economy, the weaker growth and business optimism casting a pall over the UK's growth prospects in coming months.

The output prices balance fell to 51.8 in June, its lowest level since July 2016, which indicated homegrown inflation pressures remain modest and that the effect of the pound's weakness has passed its peak.

Chris Williamson, chief business economist at IHS Markit, said: "Although the three PMI surveys are running at levels that are historically consistent with GDP growing by around 0.4% in the second quarter, it’s clear that the economy heads into the third quarter losing momentum.

“With business optimism having been hit by the intensification of political uncertainty following the general election and commencement of Brexit negotiations, at the same time that households are battling against rising inflation, the indications are that the economy’s resilience is being tested.

Markit noted pockets of growth, notably in financial services and business services, but the overall picture was dimmed by levels of business spending, investment and exports failing to provide sufficient impetus to fully offset the consumer slowdown.

“Given the deterioration in the forward-looking indicators, such as business optimism and order book growth, the risks are tilted towards the economy slowing in the third quarter.”

The weighted average of Markit’s PMIs is well below levels that has persuaded the Bank of England's Monetary Policy Committee to raise interest rates in the past, noted economist Sam Tombs at Pantheon Macroeconomics, but he continued to think that the odds of an interest rate rise this year are "very slim", not an uncommon opinion despite the recent 5-3 MPC vote.

He said the services PMI only slowing marginally in June provided "reassurance that the messy general election result and increased talk that interest rates might rise soon haven’t been calamitous for the economy".

Even so, with new orders at a nine-month low, firms confidence in the outlook has dipped, output prices indicate underlying inflation pressures remain modest, survey therefore "strengthens the hand of MPC members arguing that interest rates do not need to rise this year to tame inflation".

Philip Shaw and Victoria Clarke, economists at Investec, noted that BoE Governor Mark Carney said only this week that "some removal of stimulus is likely to become necessary", depending on the extent to which the consumer spending slowdown is offset elsewhere in the economy.

In this context, the PMIs have gained added significance as one of the earliest guides to how the economy is faring at any time, with the latest official UK figures on output of the UK’s industrial and construction sectors also due out at the end of the week to add to the picture of how the UK economy is performing along with trade figures for May on the same day.

"For the record, we see the BoE being dissuaded from raising rates over the coming months by a less than robust run of economic data, particularly on the consumer front as households face a continued cash squeeze," they concluded.

Moreover, the data in the second quarter is consistent with quarterly services sector growth of around 0.5% – well above the 0.1% rate in the first quarter, Scott Bowman at Capital Economics said, predicting on the basis of the PMIs, other survey evidence and hard data that GDP growth accelerated to around 0.5% in Q2 from the weak 0.1% in the first quarter.