Composite PMI: Slump points to recession

Time to buckle up, the economy is now almost certainly in a recession. The fall in the S&P/CIPS Composite PMI to 47.8, a two-year low, signals that, after showing some resilience at the end of last year, the economy probably contracted in January. We think the economy is now in a recession that will last until Q3 2023 and result in a drop in GDP of around 2%.

Today’s data will support the doves (economic policy advisors preferring policies that involve low interest rates) on the Monetary Policy Committee (MPC) who say that interest rates have already risen high enough, and the lagged effects will dampen demand and inflation in time. However, the rise in services inflation in December and wage growth in November mean an interest rate rise next week looks inevitable. The only question is whether it will be 0.25% or 0.5%.

The weakness was concentrated in the services sector (48.0), which also fell to a two-year low, as higher interest rates and low consumer confidence weighed on domestic demand. The manufacturing sector recovered a little, but at 46.7 the PMI is still suggesting a significant contraction.

Assuming the composite PMI remains unchanged for the rest of the quarter, a simple mapping to GDP growth points to the economy contracting by 0.3% in Q1 23. 

Employment should also start edging down soon. The employment balance remained below the 50.0 mark in January, despite edging up to 49.8, from 49.3 in December, as firms continued to respond to the sharp increase in their financing costs. On past form, that suggests the number of private-sector jobs will drop by around 0.3% quarter-on-quarter (q/q) in Q1.

We expect a 0.1% q/q drop in GDP in Q4 to be followed by 0.3% fall in Q1, 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.

The pace of price increases has continued to slow; the composite output prices index dropped to a 17-month low of 61.8, from 62.3. It reflects the continued sharp falls in the input costs of the manufacturing sector.

Interest rate peak in view

Today’s reading probably won’t be enough to alter the MPC’s rate decision next week. The fact that underlying price pressures remain too high and that the labour market isn’t cooling fast enough will probably push the committee toward another 50-basis point hike. But it will support the doves on the committee who doubt interest rates need to rise significantly higher.

Indeed, as interest rates near their peak, a slowdown in the pace of tightening is likely. With today’s PMI reading suggesting the economy might contract in Q1 23, the risk of recession remains elevated. That supports the view that the MPC will pause in May, with rates peaking at 4.25%.