22 June 2022
Time to buckle up, because the economy is almost certainly in a recession now. The fall in the S&P/CIPS Composite PMI to 47.2 in October suggests that growth will fall in Q4. The index is at its lowest level since March 2009, excluding months of lockdowns.
We expect the recession to last until Q3 2023 and result in GDP falling by around 2%. More encouraging were the drops in both in input and output prices balances, which suggest that inflation pressure may be starting to ease.
The weakness was spread across both the services sector (50.0 to 47.5) and the manufacturing sector (48.4 to 45.8) and signal that the economy shrank in October.
A lack of demand and a resurgence of supply chain issues are holding back the manufacturing sector. Indeed, suppliers’ delivery times reached their highest level in 27 months in October. The sharp drop in the services PMI is almost certainly due to the huge squeeze on consumers’ real incomes.
For now, employment still is rising; the composite index continued to exceed its 1998-to-2019 average of 50.7, despite falling to 52.6 (from 54.2). But firms cannot reduce headcounts immediately, and their pessimism about the outlook is a clue that they will move decisively to reduce employment this winter: Since 1998, the only time firms have been more downbeat about future growth in output than they are now was during the first two months of the pandemic.
We expect a 0.5% q/q drop in GDP in Q3 to be followed by a similar sized fall in Q4 as consumers reduce their spending in the face of soaring inflation and mortgage bills. Given economies across the world are weakening at the same time, it seems unlikely that firms will be able to rely on external demand to supplement a weaker domestic economy. In fact, the new export orders index fell to 43.1, its lowest level since the pandemic.
Inflationary pressures easing
All of that said, there were signs that inflation is starting to ease. The drop in the Composite PMI input prices index from 77.4 in September to 75.5 in October was the fifth consecutive monthly fall, and it takes the index roughly back to where it was last summer. It reflects continued sharp falls in the input costs of the manufacturing sector.
Overall, the inflation outlook over next year depends heavily on what austerity measures the next prime minister enacts and how they’ll reform the energy price guarantee. Removing the guarantee would mean that inflation jumps back to almost 11% in April, but we don’t think that would necessarily mean higher interest rates. The Bank of England would probably look through a one-off jump in inflation and focus on domestically generated inflation. On that basis, expect interest rates to peak at 4.5% early next year.
The fall in October’s PMI is likely to understate the economy’s performance this month. Economic growth ought to rebound in October due to the mechanical effect from the extra national bank holiday to mark Queen Elizabeth II’s funeral. However, the big picture clearly shows us that the UK economy is now firmly in recession and will stay there until late 2023.