Omicron hit the services sector in early December, going by the sharp fall in the IHS/Markit Composite PMI from 57.6 to 53.2. At the forefront of the Monetary Policy Committee’s (MPC) thinking when it meets later today will be how the latest restrictions and the threat of another lockdown will affect the economy. We think the MPC will find the uncertainty enough to delay the first interest rate hike until February.
A reading above 50.0 suggests that the economy is growing, so technically the PMI still points to a small rise in output in December. However, given that GDP growth was just 0.1% m/m in November there is a good chance that economic activity contracted in December. Falls in the output and new orders components caused the drop, which suggests that growth won’t pick up much in January either.
Of course, the PMI is just one indicator among many. But other unofficial surveys, such as the ONS’ Business Insights and Conditions survey and the near real time data, indicate recent economic weakening.
Cost pressures ease slightly
There was some good news, though. The manufacturing PMI fared better, staying at 57.6. And there’s some evidence of a relaxing in supply constraints; the input prices index fell from 89.7 in November to 84.9 in December, and the suppliers’ delivery time index rose from 21.4 to 24.6.
Remember that a lower balance indicates that firms are waiting longer to get supplies, so the supply situation improved in December. This is a sign that the surge in costs, which has helped drive inflation up to 5.1% in November, may be starting to ebb.
Similarly, the input prices balance of the services PMI fell from 82.0 to 76.4, indicating an easing of cost pressures across the economy. Inflation will probably remain around 5% until April, when it will peak at about 5.5%, but it should drop quickly as cost pressures ease and energy prices come down.
Behind the data
A more detailed look at the PMIs reveals a much sharper-than-expected fall in the services PMI, from 57.0 in November to 53.2 in December. This was driven by a big drop in business activity and new orders as omicron prompted renewed restrictions and consumer caution.
Admittedly, the employment balance of the composite PMI held up (56.0 to 55.6), suggesting that firms are still hiring and demand for labour remains strong despite the drop in output and new orders. Labour shortages are likely to continue through to the second half of 2022, as employees will take time to retrain and move to where skills are in demand.
Overall, the PMI readings suggest that the economy contracted slightly in December and is unlikely to pick up much in January. GDP may fall by around 6% if another full lockdown happens. However, if more restrictions don’t happen in winter growth should accelerate again and the MPC might raise interest rates from 0.1% to 0.25% in February.