23 February 2024: Flash PMIs show that services are leading the way

Following the muted response from the Government and the Bank of England to last week’s news that the economy had slipped into a recession, it was predictable that both had advanced knowledge that the contraction would be short-lived. However, the market wasn’t prepared for growth to return as quickly as it has.

Yesterday’s publication of flash Purchasing Managers Surveys bore out the Prime Minister’s assertion that the country had “turned a corner” since the start of the year.

As has been the way for several years, the economy has become based upon increased productivity from the services sector as the country found that it couldn’t compete with the manufacturing capability of developing nations, the most obvious of which is China.

Services now account for 80% of UK GDP. The January data showed that services output rose to a high of 54.3, better than the predicted rate of 54.1.

Although manufacturing output continues to struggle, the composite index rose from 52.9 to 53.3. The private sector is beginning to pick up pace, having expanded for the fourth consecutive month in January and at its fastest pace since last May.

New orders, productivity, and employment are all showing improvement in the private sector.

It is now well above the 50 level, below which output is contracting. The PMI is a composite index based on equal weights (20%) of the following five primary sub-indexes: New Orders, Production, Employment, Supplier Deliveries, and Inventories.

The “dip” into a “mild recession” in the fourth quarter of 2023 was due to items which are not considered in PMIs, which only look at manufacturing and services output. The exclusions include retail, which saw a fall in December, public services which have been hit by strikes in several sub-sectors and energy which suffered for the whole of 2023.

Both Andrew Bailey and Jeremy Hunt reacted to the news that the country was in recession by noting that since “meaningful” growth had been hard to find over the past year, it wouldn’t have taken much of a slowdown to tip the economy into recession.

Sterling reacted positively to the news, climbing to a high of 1.2709 before day traders’ profit-taking saw it fall back to close at 1.2661.

The expectation that the FOMC will cut interest rates in the next few months is gathering pace, primarily due to the comments from several Regional Fed Presidents, who are prepared to be “persuaded” that inflation is continuing to moderate while the employment market remains resilient.

There are a couple of exceptions to this general air of dovishness. Mary Daly, President of the San Francisco Fed, and Loretta Mester, her colleague from Cleveland have been calling for patience, both feeling that since the FOMC has driven inflation down to the cusp of its 2% target, a confirmation is needed that inflation won’t flare up again should rate cuts take place “too soon”.

It is interesting to note that both the Fed Chair, Jerome Powell, and his Deputy, Phillip Jefferson, also remain hawkish about cutting rates too soon.

This small but influential group was joined yesterday by a further permanent member of the rate-setting committee. Patrick Waller, a Fed Governor, spoke of his opinion that more evidence is needed to ensure that inflation has cooled sufficiently for cuts to begin.

Waller’s view chimes with the market opinion that the start of rate cuts is still uncertain, as is the rate that the Fed is expecting to achieve.

One of the main drivers of the Fed’s caution is the continued robustness of the employment market.

Weekly jobless claims data was published yesterday. Since the beginning of the year, the four-week average has remained consistent, between 205k and 215k new claims weekly. This points to a gradual cooling of job creation, something that the hawks will want to see continue before agreeing to a rate cut.

With the economy having created more than 300k new jobs in each of the past two months, some fear that it may be in danger of overheating and a hike in rates may be needed if this continues. No other data is pointing to such a situation, and it may be that the economy has entered a new phase post-pandemic.

As is normally the case, more data will be needed to confirm this.

The dollar index broke its medium-term support at 103.90 yesterday, making a low of 103.43. However, it quickly regained its composure and recovered to close at 103.94.

The next release of employment data will take place on March 8th given that the first of the month falls on a Friday, while inflation data for February will be published on March 12th and the FOMC will meet on March 20th.

The positive tone of PMI data in the UK was repeated in the Eurozone, except for Germany where manufacturing output collapsed, falling from 45.5 to 42.3.

In the Eurozone as a whole, manufacturing output remains in decline, but it does appear to have bottomed out. The composite index of manufacturing and services rose to 48.9 from 47.9 due to the services component, which showed that output returned to expansion, reaching 50 from 48.4 previously.

The harmonized inflation index for the entire Eurozone was unchanged at 3.3%, while both France and Italy saw economic output improve despite both remaining in contraction.

The Eurozone economy is beginning to show a decent level of resilience, despite the issues faced by Germany.

It does appear blindingly that the entire region would benefit from a rate cut, although the ECB’s Governing Council wants to be convinced that inflation is firmly on a path towards its 2% target before agreeing.

The Eurozone economy is viewed through the lens of its largest economies, Germany, France, Italy, and Spain. However, post-pandemic performance depicts a resilience that has not been seen before. It is unclear whether nations like The Netherlands, Belgium, Ireland, and Portugal were reliant on Germany, or they just existed in its shadow.

They are now beginning to flourish as the German “pain” continues. The nations that were in the “soviet orbit” are resisting the supposed threat of Russian hegemony and are also doing well as their economies react to greater financial discipline brought about by restrictive interest rates that have seen their elevated levels of inflation brought under control.

It may well be folly of the ECB to expect these nations to see their inflation rates fall to the levels of more “established” economies, but at least they subscribe to the Central Bank’s desire to tame inflation.

The euro continues to defy gravity, driven by a combination of ECB hawkishness and what has become a significant correction for the dollar. The common currency rose to a high of 1.00888 yesterday, but quickly ran out of steam and fell back to close at 1.0821.

Have a great day!