Bank of England more likely to increase interest rates as inflationary pressures rise

This article is more than 2 years old

This article is more than 2 years old

The UK economy has bounced back from a soft patch in the opening months of 2018, according to a closely watched survey of the services sector that showed stronger than expected activity last month.

In the latest sign that bad weather held back the economy during the first quarter, the health check by the Chartered Institute for Procurement and Supply and IHS Markit reported the strongest growth in eight months.

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IHS Markit’s chief economist, Chris Williamson, said the improvement shown by the service sector, which accounts for just under 80% of GDP, suggested the economy would expand by 0.4% in the second quarter – double its rate of growth between January and March.

A breakdown of the survey showed that demand was strong for business and financial services, while the hot weather led to a pick up in consumer spending in bars and restaurants.

With the June IHS Markit/Cips surveys for manufacturing and construction also beating expectations, the City said chances of an August interest rate rise from the Bank of England’s monetary policy committee (MPC) had increased.

“Stronger growth of service sector activity adds to signs that the economy rebounded in the second quarter and opens the door for an August rate hike, especially when viewed alongside the news that inflationary pressures spiked higher,” Williamson said.

“It remains encouraging, yet also surprising, that current business activity continues to show such resilience amid relatively moribund confidence regarding the year ahead outlook.”

The IHS Markit/Cips purchasing managers’ index rose from 54.0 in May to 55.1 in June, with reports of a robust and accelerated pick-up in activity. Any reading above 50 indicates that the sector is expanding.

Ruth Gregory, a UK economist at Capital Economics, said it was possible the survey was underestimating the bounce-back in the economy because its findings did not include reports from retailing, where high-profile business failures were offset in recent months by falling inflation, the royal wedding and the recent fine weather.

“The fact that the services survey also contained signs of a strengthening in domestically generated inflation also bolsters the chances that the MPC will press ahead and hike interest rates soon,” Gregory added.

Inflation was 2.4% in May and is still above the government’s 2% target despite falling back in recent months.

Three of the nine members of the Bank of England’s monetary policy committee voted for a quarter-point increase in official borrowing costs when it met last month but Threadneedle Street’s quarterly update on the economy will be released in August and is seen as a more likely date for a move.

However, some analysts said the Bank might again delay raising rates – as it did in May – once hard economic data came in over the next few weeks. That will include a new report from the Office for National Statistics tracking growth on a monthly basis.

Dean Turner, a UK economist at UBS Wealth Management, said: “Our expectation is that the data will not be strong enough to encourage the Bank to hike as soon as August.”

Businesses in the services sector, which include bars, restaurants and hotels, and accounts for about three-quarters of the UK economy, took on new work at the fastest rate in just over a year. Firms said product launches, marketing initiatives and improving economic conditions helped increase business.

But companies reiterated that Brexit-related uncertainty had held back investment, affecting spending by large companies in particular.

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At the same time, business costs have risen sharply on the back of surging oil prices and the need to offer higher wages.

IHS Markit reported similar findings in its survey of the eurozone, where a pick-up in business activity in June pointed to 0.5% GDP growth in the second quarter, up from 0.4% in the first. Economists said this should encourage the European Central Bank to start tightening policy later this year.