UK services PMI falls to lowest since 2013, rate hike 'put to bed'

UK services activity declined much more than expected in February as economic growth slowed to its weakest for almost three years, according to Markit-CIPS data, leading economists to dismiss the possibility of a Bank of Interest rate rise in 2016.

The Markit-CIPS services purchasing managers' index (PMI) sank to 52.7 for February, well short of the expected 55.1 and the previous month's 55.6.

One group of economists suggested the fall looked to be a repeat of that seen in August and September, when financial market weakness led to a sharp decline in the services sector PMI.

An all-sector PMI for February hit a 34-month low of 52.9, down from 56.1 in January as the index crashing to its biggest fall since August 2011, which Markit said was "historically consistent with Bank of England rate cuts".

With the rate of job creation the weakest for two and a half years, Markit said its survey signalled UK gross domestic product grew just 0.2% in February and could slow to 0.3% in the first quarter of 2016 from 0.5% in the final quarter of last year.

Rate rise off the table?

As inflation seems set to remain below 1.0% until the end of the year, the reasons for the BoE to raise rates this year appeared to be diminishing - and even raising the possibility of monetary policy loosening.

“The extent of the slowdown will be a shock to policymakers and surely puts to bed any talk of the Bank of England raising interest rates," said Chris Williamson, Markit's chief economist.

"The focus will instead increasingly shift to whether policymakers may soon need to dig deeper into their toolbox to introduce new measures to shore-up the economy with additional stimulus, and what tools might be used. History shows that the PMI has now moved down into territory normally consistent with the central bank cutting interest rates rather than hiking."

He added that February's PMI alone was consistent with just a 0.2% quarterly rate of GDP growth, and there may be worse to come.

"Despite rising slightly compared with January’s three-year low, business confidence in the service sector remained at a level which has historically presaged an imminent slowing in the economy to near-stagnation or worse in coming months."

On the upside, the survey showed a slight rise in the backlogs of work index, to 50.8 in February from 49.0 in January, and the future activity index, to 68.3 from 67.5.

Economist Sam Tombs of Pantheon Macroeconomics agreed the exceptionally weak business activity data and new orders index provided "the clearest indication yet that uncertainty created by the EU referendum is hurting the economy".

He added that the slight rise in the backlogs of work index and future activity index suggested growth in activity was likely to pick up "marginally" soon but the drop the main activity index chimed with weaker evidence from other surveys produced by the CBI and the EC.

Tombs also agreed that a weighted average of the manufacturing, construction and services PMIs points to quarter-on-quarter GDP growth slowing to about 0.2% in Q1.

He also produced a chart that shows that the index is now close to levels that in the past have prompted the MPC to ease monetary policy.

"But with the tight labour market and the weaker exchange rate likely to lift inflation back to its target, we think the economic recovery likely will have to grind to a complete halt for the MPC to cut rates this time."

Economists at BNP Paribas suggested the fall was a repeat of those in 2015 when financial market weakness led to a sharp decline in the services sector PMI.

They pointed out that in September, even when the composite PMI fell sharply, GDP growth in the third quarter still came in at 0.4% q/q.

"Moreover, if the weakness in the services PMI is related to the volatility in markets, the rebound in the FTSE over the past few weeks, should lead to some recovery over the next couple of months."

BNP added that the consensus forecast of 2.2-2.3% GDP growth in 2016 appeared "increasingly optimistic and will probably start to fall. With growth around trend, or a little below, in the first half of the year and inflation set to remain below 1.0% until Q4, there is little to suggest that the BoE will raise rates during 2016, contrary to the consensus expectation."