The UK service sector has posted its best rise in activity since October 2017 which has re-ignited speculation that the bank of England will increase interest rates next month. This news will be hailed in certain quarters as “proof” that Brexit concerns are nothing but “project fear” and the UK economy is back on track, but when the UK economy has gone from the fastest expanding G20 economy to the slowest, since the Brexit vote, such statistics flatter to deceive.
The evidence (such as it is) for a recovery in the service sector which accounts for 80% or so of UK GDP is the purchasing manangers’ index for the sector in June which shows a rise over the May figure from 54 to 55.1 (on this scale, any value above 50 indicates an expansion). It is seen as evidence that the poor Q1 growth (even by UK standards) will be a blip and that Q2 data will be stronger. Thus, an interest rate hike is back on the cards and Sterling will track higher on the strength of this expectation.
IHS Markit who produce the PMI data estimate that the UK GDP will post Q2 growth of 0.4% in Q2 up from the Q1 figure of 0.2% (which may, or may not, have been stymied by an unusually hard winter). This level of performance needs to be judged against Q2 growth in other G7 nations and the Eurozone to be put in context when the data emerges.
Markit’s Chris Williamson noted: "The sharp rise in business costs, linked to surging oil prices and the need to offer higher wages, suggests inflation will also pick up again from its current rate of 2.4%. Nonetheless, there were again reports that Brexit-related uncertainty had held back business investment, particularly in relation to spending by large corporate clients."
Whilst normalising UK interest rates towards their historic average, a rise ought to have the effect of reducing inflationary pressure by tightening the money supply (however, with rates close to their historic low, this effect may be marginal).