Industrial recession and cost of living pressures put the UK economy on a contractionary course

LONDON, Aug 23 (Reuters) – Britain’s economy will shrink in the current quarter and risk falling into recession, a survey on Wednesday showed a decline in factory output and broader weakness in the face of higher interest rates.

The S&P Global/CIPS composite purchasing managers’ index (PMI) fell to 47.9 in August from 50.8 in July, a preliminary estimate below all forecasts in a Reuters poll of economists.

The reading was the lowest since January 2021, when Britain was under a COVID-19 lockdown, and the first drop below the 50 level that separates growth from contraction since January this year.

Britain’s economy – hit by high inflation and the after-effects of the coronavirus pandemic and Brexit – last contracted in the third quarter of 2022, with many businesses closing to mark Queen Elizabeth’s funeral. Since then, it has defied widespread predictions of a recession, but has grown slowly.

Chris Williamson, chief business economist at S&P Global Market Intelligence, said the PMI pointed to a 0.2% drop in overall economic output in the three months to the end of September.

„The fight against inflation carries high costs in terms of elevated recessionary risks,” he said.

Eurozone composite PMI came in at 47.0, below all economists’ forecasts, up from 48.6 in July.

Sterling fell against the dollar and the euro and British government bonds headed for their biggest daily declines in more than a month, as investors cut expectations of further interest rate hikes.

The Bank of England has raised rates 14 times since December 2021 to a 15-year high of 5.25%. Financial markets still expect rates to rise to 5.5% in September, but now expect rates to be 5.75% rather than 6%.

„The PMIs are unequivocally bad,” said James Smith, economist at ING. However, he said he did not expect a contraction in the third quarter after a strong finish in the second quarter and other data showing a recovery in car production.

Nevertheless, the figures highlight the risk of the BoE focusing too much on wage inflation, which often lags behind other economic developments, he said.

Reducing price pressures?

British inflation has been slowing since hitting a 41-year high of 11.1% last year, and was the highest of any major economy at 6.8% in July.

S&P’s Williamson said he expected it to fall to 4% „in the coming months.” The BoE said earlier this month that it sees inflation below 4% from the second quarter of 2024.

The PMI survey also recorded slower growth in producer prices after February 2021.

Services prices, which the BoE is closely monitoring, grew at their slowest pace since April 2021.

Manufacturers – which account for 10% of Britain’s economy – reported the biggest fall in output prices since February 2016, echoing broader weakness in the sector.

The manufacturing PMI fell to 42.5 from 45.3 in August, the lowest since May 2020, while the services sector fell to 48.7 from 51.5, matching January’s two-year low.

„Companies reported reduced orders for goods and services as demand increased due to the cost-of-living crisis, higher interest rates, export losses and concerns about the economic outlook,” Williamson said.

In the depths of the global financial crisis, consumers stockpiled manufactured goods at the fastest rate since March 2009.

Manufacturers said the drop appeared to be an attempt to reduce the need for working capital at a time when interest rates are rising. They believed it would be a one-time move as there was a limit to how much stock levels customers could reduce.

Service firms said households had stretched funds, only partially offset by strong tourism demand.

Overall business confidence for the coming year fell to an eight-month low, but the spread remained in line with its pre-pandemic average.

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