22 February 2023: Services PMI roars into expansion

The UK economy demonstrated its unpredictability yesterday by bouncing back in the most unexpected way as it recorded a significant level of activity.

The Purchasing Managers indices showed that service sector output returned to expansion, rising above the 50 level which denotes the divide between expansion and contraction, to reach 53.3 from 48.7 in January.

This, when combined with manufacturing output, produced a composite reading of 53, again up from 48.3 last month.

A possibly even greater surprise was the fall in Public Sector net borrowing, which fell by close to six and a quarter billion pounds. This opens up a whole range of new possibilities for the Government, and it is no coincidence that the latest nurses strike has been called off in light of a new and intense round of negotiations that now may see more money being available.

If it can be maintained in the coming months, the level of activity shown in January would mean that a recession would be off the table and would provide a significant feelgood factor that would benefit all areas of the economy, although the cost of living still remains an issue despite the fall in the wholesale price of gas, which is 80% lower than it was at its peak last August.

Although the Government plans to raise the cap on energy prices in April, very few households would benefit since the gas price is now close to the current cap level.

Housing and employment remain of concern to economists since the rise in house prices has completely stagnated, which is a reaction to higher rates of interest being charged by home loan lenders, while it is understood that since January there has been a significant rationalization taking place in the food retail sector.

Two of the largest chains, Tesco and Morrisons, are rumoured to have cut around 14k jobs in an effort to streamline some of their operations to deal with changing dynamics in the sector.

Food price inflation is expected to set a new high this month as supermarkets are being forced to ration several varieties of vegetable including tomatoes and potatoes to deal with significant shortages due to poor crops being seen in Southern Europe and North Africa due to unseasonable weather.

Given the upbeat data that was released yesterday, it is likely that consumer confidence data due for release on Friday will also show a significant improvement.

The pound rallied to a high of 1.2148 against the dollar as the notion of a recession was pushed to the back of traders’ minds. However, it was unable to create any further momentum and slid back to close at 1.2105.

As discussed yesterday, the regional nature of just about every area of the economy was highlighted by the PMI data for February. The composite PMI managed to claw itself above the fifty level, reaching 50.2 up from 46.2 in January.

However, there is still a significant regional gap developing, with the northern half of the nation faring far better than the south. If this becomes a recurring theme across employment, housing and output, there may be a more significant discussion to be had at the next FOMC meeting.

The minutes of the most recent rate setting meeting are due for release today and the most interest will be generated by the conversation over the eventual hike in short term interest rates of twenty-five basis points following a series of fifty point hikes in the months leading up to year-end.

It will be interesting if the regional effect was already being considered and how Jerome Powell was persuaded to set aside for at least one meeting his desire to sustain a level of rate hikes that showed the markets that the Central Bank still sees lowering inflation as its number one priority.

Once the minutes have been digested, investors, commentators and analysts will turn their attention to the next two significant events. Next Friday, the February employment report will be published. The market’s attention will be drawn to the headline non-farm payrolls number and any correction to the January data. It will be a major surprise if the January figure of 537k new jobs is repeated, and equally important will be a major correction.

Then, a couple of weeks later, the next FOMC meeting is scheduled to take place. A pause in hikes as well as twenty-five and fifty point hikes are all on the table as the market appears to be interpreting itself to death in trying to disseminate Fed policy from the background noise.

President Biden, in Warsaw following his visit to Kyiv the previous day, confirmed that NATO is solidly behind Ukraine in its war with Russia. Biden refuted Vladimir Putin’s speech earlier in the day in which he said that Russia’s invasion of its neighbour was in response to western aggression, while he also blamed the U.S. for fanning the flames with its support for Kyiv.

Biden promised a new package of aid for President Zelensky, but fell short of providing F16 fighters, an issue he is believed to be still considering.

The dollar index remained at the upper end of its recent range despite stronger data released by the UK, and Eurozone. The proximity of the FOMC minutes deterred traders from taking any major new initiatives.

The index rose to a high of 104.26, closing at 104.19.

Confidence is flowing again through the Eurozone as its energy crisis appears to be coming to an end, while economic activity is gaining a significant amount of traction.

Output data for the entire Eurozone provided a consolidation of its recent improvement, moving well into expansion, while in Germany the ZEW survey made up for poor current expectations by showing a far stronger than expected reading for economic sentiment.

A significant fly in the ointment is the likelihood of the ECB continuing to raise interest rates well past the long expected March cut-off date.

Senior Central Bank officials, particularly from the more hawkish side, maintain that rates are not yet close to restricting demand and by doing so drive inflation lower.

Having raised rates by fifty basis points to 3.25% a few weeks ago, the Central Bank is certain to add another fifty points at its March meeting.

ECB president Christine Lagarde defended her testimony to the European Parliament recently in which she confirmed the March hike by saying that the ECB is data driven, and the data speaks for itself.

Lagarde softened her tone by saying that any tightening at subsequent meetings will remain data dependent, but there may be some room for consideration of requests for a pause to consider the overall effect of tighter policy.

President Biden’s comments in Warsaw yesterday are something of a double-edged sword for the European Union. While he showed total support for NATO, something that was lacking under the previous President, the words place the Union front and centre in supporting Ukraine and its people.

With Russia expected to launch a major offensive in the coming weeks, that support will need to be both reliable and effective.

Yesterday, the Euro fell against the dollar as the improving economic data was more than matched by the U.S. It reached a low of 1.0637 and closed at 1.0645.

Have a great day!