The UK’s private sector has experienced a significant downturn in August, attributed to lower new orders and increased borrowing costs.
This development has raised concerns about the economy’s potential entry into a recession.
Notably, this downturn marks the first monthly decline since January.
Businesses have been heavily impacted by recent interest rate hikes, which have reached a 15-year high of 5.25%.
This situation is particularly concerning as it represents the most substantial setback for the economy since January 2021, a time when the UK was grappling with the effects of the Covid-19 pandemic.
S&P Global/CIPS Flash PMI Highlights Economic Challenges
The S&P Global/CIPS flash UK Purchasing Managers’ Index (PMI), a closely watched indicator, dropped to 47.9 in August, a decrease from July’s 50.8 reading.
Economists typically interpret any PMI figure above 50 as indicative of sector growth, while a value below 50 signifies contraction.
The reported PMI figure fell below economists’ expectations, as a consensus forecast had anticipated a reading of 50.3 for the month.
The survey findings indicated shrinking activity in both the manufacturing and services sectors.
The services industry, which had been a significant growth driver in recent months, experienced one of its most substantial declines in output over the past 31 months.
Meanwhile, the flash manufacturing industry reading was 42.5, the lowest in 39 months, primarily due to a sharp and rapid decrease in production volumes.
Challenges in New Orders and Inflation
The survey revealed a decline in new orders across all industries for the second consecutive month.
Surveyed firms cited client reluctance to spend, attributed to higher interest rates and stretched household incomes.
Although inflationary pressures had somewhat moderated in August, with input costs rising at a slower pace, persistent wage pressures were still reported.
Private sector companies in the UK also raised their average prices, but the rate of increase was the softest since February 2021.
Business Optimism and Economic Outlook
Business optimism for the year ahead reached an eight-month low but remained broadly in line with pre-pandemic averages.
The release of this data led to a decrease in the value of the pound against the dollar.
The Bank of England, under the leadership of Governor Andrew Bailey, has raised interest rates 14 times since December 2021, reaching a 15-year high of 5.25%.
Financial markets are anticipating a further rate increase to 5.5% in September, with expectations of rates peaking at 6% later in the year.
Despite efforts to address high inflation through interest rate hikes, UK inflation remains stubbornly high compared to other major economies.
Experts Warn of Recession Risks
Some experts have cautioned that the recent data could signal an increased risk of recession due to measures taken to curb inflation by raising interest rates.
Chris Williamson, Chief Business Economist at S&P Global Market Intelligence, suggested that while inflation might moderate in the coming months, the fight against inflation is posing substantial risks to the economy.
A renewed economic contraction appears likely, with both the manufacturing and service sectors showing signs of decline.
The survey’s findings indicate a potential GDP decline of 0.2% over the third quarter.
Bank of England’s Considerations and Economic Expectations
Martin Beck, Chief Economic Advisor to the EY Item Club, noted that the slowdown in both activity and inflation should influence the Bank of England’s upcoming interest rate decision.
This situation suggests that a rate increase is no longer a certainty.
The EY Item Club believes that while the survey findings might not dissuade the Bank of England from raising rates again, recent developments in pay and services inflation could contribute to this decision.
However, the survey results do reinforce the expectation that any rate increase in the near future could be the final one in the current rate-hike cycle.
Economic Impact and Respite for Supply Chains
John Glen, Chief Economist of the CIPS, highlighted the positive aspect of reduced activity, indicating that it has provided much-needed relief to UK supply chains after two years of instability.
The impact of high interest rates is becoming evident in dampened demand and reduced inflationary pressures, leading to moderated input costs and lower raw material prices for manufacturers.
The UK economy, grappling with high inflation and the lingering effects of the pandemic, experienced its last contraction in the third quarter of 2022.
While it defied predictions of recession, it has been growing slowly since then.