The UK is benefiting from a post-election bounce in business confidence, according to new data, but economists say there is little guarantee of a lasting recovery in economic growth — making the Bank of England’s interest rate decision next week the most unpredictable for years.
A key business activity survey published on Friday — the flash IHS Markit/Cips composite purchasing managers’ index — rose to 52.4 in January, from 49.3 in December.
This meant that a majority of companies were reporting expanding activity, driven by renewed strength in the service sector and conditions in manufacturing stabilising after a period of weakness.
The PMI is one of the clearest indicators so far that companies are starting to feel more upbeat after the Conservatives won an 80-seat House of Commons majority at the December election and some of the uncertainty around Brexit was reduced.
Other recent evidence of activity picking up in the housing market and car sales rising in December could point to consumers feeling more confident about big spending decisions.
But surveys of business sentiment often overstate the impact of political events on actual economic activity — and the latest PMI may not be enough to convince the BoE’s Monetary Policy Committee on Thursday next week that the economy has turned a corner, after its contraction in the run-up to the election.
Four of the MPC’s nine members have recently made the case for cutting interest rates should there be no clear improvement in economic data.
The latest official data paint a very mixed picture. The labour market remains strong, with employment reaching a record high even in the run-up to the election. But wage growth has eased, retail sales have not increased since July and inflation is well below target at 1.3 per cent.
Investors now view the MPC decision next week as being on a knife edge, with pricing in futures markets suggesting the odds of a rate cut are little more than 50/50 — with a slightly stronger probability of a move by March.
The PMI was “neither strong enough to rule out a January cut, nor weak enough to guarantee it”, said economists at Bank of America, calling the decision “effectively a coin toss”.
Some economists said the latest data give the MPC grounds to leave rates on hold and wait to see whether the pick-up in business sentiment translates into an improvement in economic activity.
“The rebound in the activity surveys might prompt the MPC to take a rain check [until its March meeting]”, said Ruth Gregory, economist at the consultancy Capital Economics.
She argued that by then, policymakers would know whether economic growth and inflation were picking up, and would also be able to factor in the size of any fiscal stimulus that chancellor Sajid Javid might announce in his March Budget.
But she added that the MPC vote next week would be close — and that the possibility of a rate cut would linger for months.
Philip Shaw, economist at Investec, said the decision would be “the least predictable for some time” and would depend chiefly on “the extent to which the MPC believes the signs of a bounce are sufficient and genuine”.
But he too predicted that the MPC would resist the urge to cut rates — pointing to Anglo American’s bid this month for the UK potash miner Sirius Minerals as one concrete example of renewed corporate activity that could deliver a much-needed boost to business investment.
However, there are also strong arguments to justify the MPC pressing ahead with a precautionary cut in rates.
Michael Saunders, an external MPC member, argued this month for “a relatively prompt and aggressive response to downside risks”, because the BoE no longer had as much firepower as in the past to fight a severe economic downturn.
If the BoE were to cut rates now and the move turned out not to be needed, it would be relatively easy to raise them again and get inflation under control, on this argument. But if it failed to act and the economy took a turn for the worse, it might not have enough ammunition to fight a recession.
Even without making this case for an “insurance” rate cut, policymakers may be reluctant to read too much into the apparent improvement in the state of the economy.
Fabrice Montagné, economist at Barclays, argued that even after the latest improvement, the purchasing managers’ indices were still barely back at their long-term averages.
George Buckley, economist at Nomura, said a weaker global environment could be a further factor in the MPC’s deliberations: the latest data from the eurozone cast doubt on the prospects of a recovery in the UK’s main export markets, and the IMF this week issued a new set of downbeat forecasts for global growth.
The dynamics of the MPC meeting next week may be especially unpredictable, because it is the last to be overseen by Mark Carney, the outgoing governor. Until now, the five internal members of the MPC led by Mr Carney have voted in line with the governor on most occasions.
“It is not difficult to imagine Carney voting to cut rates, in a move reminiscent of ECB president Mario Draghi’s decision . . . to loosen policy only a few months before Christine Lagarde took over,” said Ms Gregory, adding that Mr Carney might also “be reluctant to rock the boat only a few months before [his successor] Andrew Bailey takes the helm”.