Weakening recovery suggests MPC will need to tread lightly

The stability in the composite activity PMI in September indicates that GDP growth was pretty flat last month, and there was more evidence that firms are starting to raise prices in response to the ongoing cost pressures. 

The combination of a weaker economic recovery and rising inflation highlights the tricky position the Monetary Policy Committee (MPC) finds itself in. The MPC seems to be putting more weight on rising inflation than the weakening economy, which raises the risk that it tightens monetary policy before the economy has properly recovered from the pandemic. This could put the economy onto a permanently lower path. 

The composite Purchasing Managers’ Index (PMI) is a measure of health in the manufacturing and service sectors. The tiny uptick in the final reading of September’s composite PMI is better than the small fall the flash had suggested would happen, but it still suggests that the initial surge in activity from the reopening of the economy has run its course. It indicates that GDP growth in Q3 will be less than the MPC forecast at its last meeting in September, and could be weaker than the 1.5% quarter-over-quarter that we have pencilled in. 

The services PMI is based on the results of a survey of service sector firms across the UK. Results above 50 indicate that the sector is expanding, and the services PMI has increased from 55.0 to 55.4. This, in turn, spurred a rise in the composite PMI, but it was partly offset by a drop in the manufacturing output index, from 54.1 to 51.8. Information provider IHS Markit highlighted that survey respondents had said that shortages of both materials and labour were the main things preventing firms from ramping up output. 

Perhaps the most eye-catching part of the survey was the jump in the prices components of the composite PMI. The input prices balance remained close to its record high, suggesting that firms are still experiencing rising costs. The output prices balance rose to an all-time high, which indicates that firms are increasingly passing on cost increases to their customers. 

There was a small drop in the employment component of the composite PMI, but it still points to strong annual employment growth of around 2.0%. This is especially positive, as it suggests that firms didn’t get rid of labour in response to the winding down of the furlough scheme in September.