UK purchasing managers subdued at start of Q3

Business activity in the UK's services sectors continued to expand in July, increasing the pace from the previous month, but the latest survey of Britain's supply executives revealed a rather subdued outlook.

Similar muted sentiment was expressed in a survey of purchasing managers in the construction industry on Wednesday as business activity slowed in the building industry.

Manufacturing remained a bright spot in the outlook for the UK economy in the second half of the year as activity among the country's producers accelerated in July.

Overall, then, a mixed picture emerged: an economy that appears to be stuck in the limbo between expansion and downturn.

Nothing typifies this better than the contrast between consumer price inflation (CPI) running at an annual pace of 2.6%, and annual average wage growth at 1.8%.

But let's get back to this week's purchasing managers' indexes (PMI).

The service sector showed accelerating growth, but purchasing managers are turning bearish on the outlook - Source: Shutterstock

The services sector

The headline index rose to 53.8 in July from 53.4 in June, remaining above the 50 level that indicates expanding activity for the twelfth-consecutive month.

This rise largely reflected a boost in job creation, which edged up to its strongest level in a year and a half.

Survey respondents said rising economic uncertainty and fragile confidence among clients appeared to be putting the brakes on growth.

The construction sector

Construction PMI fell to 51.9 in July, from 54.8 in June, falling a long way short of an estimated 54.5 reading.

IHS Markit's survey revealed a reduction of new business for the first time in 11 months, with lower levels of activity in commercial development and a softer expansion in house building.

Respondents noted delays in decision making by clients worried about the economic outlook and other uncertainties linked to political instability and Brexit.

Manufacturing remains a bright spot, but raw materials prices are rising due to the weak pound - Source: Shutterstock

The manufacturing sector

Tuesday's manufacturing PMI for July rose to 55.1 from 54.2 in the previous month, beating an expected rise to 54.3.

New work inflows and increases in production illustrated the contrast between manufacturing and the services and construction sectors. However, this was the first time activity had accelerated in three months.

What has led us here?

Having taken a plunge in the immediate aftermath of last summer's EU referendum, the pound has still not recovered – remaining nearly 9% lower against the dollar and 12% lower versus the euro.

This means that to a large extent, the 2.6% rate of inflation has been imported due to higher costs of overseas goods, services and materials.

One thing all three PMIs revealed was rising employment in each sector. Yet employers have been able to keep their wage costs low. How?

Many are citing slowing consumer demand, which reveals an impasse between employer and consumer.

Employers are concerned about future growth, in part due to the inflationary impact on raw materials costs over which they have no control. One of the costs they can control, however, is salaries.

Meanwhile, consumers are caught between higher prices and low wage growth causing a squeeze on household spending.

"Uncertainty over consumer demand, combined with rising costs from higher import prices, mean that firms are unlikely to accelerate wage gains," says James Smith, economist at ING.

Disappointing first-half growth

Gross domestic product growth increased only 0.3% quarter-on-quarter in the April-June period. This came after a quarterly rise of just 0.2% in the first three months. This left the annual growth rate at 1.7%.

The question investors would now like answered is: does the survey evidence now point to further weaker levels of growth ahead?

Some seem to think so – even the Bank of England.

On Thursday, the BoE cut its growth forecasts for 2017 to an annual 1.7% from its previous estimate of 1.9% due to low wage growth. Growth in 2018 is now seen at 1.6%, down from 1.7%.

The outlook for Q3

"The surveys show that there is tentative evidence the slowdown in growth in the first half does not look like a blip," says Sam Hill, economist at RBC Capital Markets.

Samuel Tombs at Pantheon Macroeconomics says: "The weighted average of the manufacturing, construction and services PMIs in July is consistent with quarter-on-quarter growth in GDP of about 0.3%, the same as in the second quarter."

We'll leave the last word to Chris Williamson, economist at IHS Markit, the compiler of the PMI reports.

"While the current picture remains one of an economy showing overall resilience in the face of concerns about the outlook, the subdued level of business optimism suggests it’s likely that growth will at least remain modest and could easily weaken in the coming months."