Following the falls in the manufacturing and construction surveys, the smaller decline in the headline business activity balance of the services PMI, from 51.0 in May to 50.2 in June, was a bit of a relief. Nonetheless, the weak surveys have caused us to revise down our estimate for quarterly growth in Q2 from -0.1% to -0.2%.
Relatively resilient services sector won’t prevent contraction
- Following the falls in the manufacturing and construction surveys, the smaller decline in the headline business activity balance of the services PMI, from 51.0 in May to 50.2 in June, was a bit of a relief. (See Chart 1.) Nonetheless, the weak surveys have caused us to revise down our estimate for quarterly growth in Q2 from -0.1% to -0.2%.
- The fall in the headline services index was below the consensus forecast of an unchanged reading. And based on past form, it suggests the services sector stagnated in Q2 following a 0.4% q/q expansion in Q1.
- But, taking a step back, it is only a little below the average of 50.5 over the past six months. Given the survey underestimated growth in the sector in Q1, we suspect it has continued to under-egg services output somewhat. But even if services output rose by 0.1% q/q in Q2, as we have pencilled in, a contraction across the economy as a whole probably hasn’t been avoided.
- The manufacturing PMI fell from 49.4 to 48.0 in June (the lowest in seven years) and the construction PMI dropped from 48.6 to 43.1 (the lowest in a decade). As a result, the all sector PMI dropped from 50.7 to 49.2 – its lowest level since the EU referendum. That’s consistent with quarterly GDP growth of -0.1% in Q2. But just as the survey underestimated the boost to GDP from Brexit preparations in Q1, we suspect it has underestimated the payback in Q2. We’ve revised down our estimate of Q2 GDP from -0.1% to -0.2% q/q.
- A shift in activity to before the Brexit date accounts for some of the recent weakness. But the fact the surveys have not picked up towards the end of the quarter, and the global manufacturing sector is slowing, suggests that there is a risk that the economy fails to bounce back significantly in Q3.
- It isn’t all bad news, though, some of the other balances of the services PMI improved. The backlogs of work and employment balances of the survey, which are historically the best guides to how the services sector will fare over the next few months, ticked up to an eight- and 22-month high respectively! The composite employment PMI also rose to its highest level in over a year. So the dip in activity does not appear to be translating into a weaker labour market.
- Overall, the economy clearly lost momentum in Q2. That was always going to be the case after the pre-Brexit boost in Q1. But we are getting more worried that the underlying trend has weakened too.
Chart 1: IHS Markit/CIPS PMIs
Sources: IHS Markit, Capital Economics
Andrew Wishart, UK Economist, +44 20 7808 4062, email@example.com