United Kingdom

Chances of an earlier-than-expected hike in interest rates increase

The prospect of a rise in interest rates by the Bank of England sooner than anticipated increased today after UK service sector companies saw the highest level of both cost and price inflation in a quarter of a century in July. 

Businesses in the sector, which include restaurants, hairdressers as well as banks and insurers, were forking out more for wages, transport and food, with costs rising at the fastest pace in 25 years, according to a new survey. 

And companies are beginning to pass on these costs to customers, with selling prices rocketing to the highest level not seen since 1996, when the IHS Markit/CIPS Services PMI survey started.

UK service firms, which include restaurants, saw a slowdown in growth in July

Signs of rising inflation are coming from other industries too. Factories saw input costs rise at a near-record pace in July, leading to a near-record increase in manufacturers' selling prices.

Yesterday, builders' merchant Travis Perkins said that the costs it pays for raw materials rose by 7 per cent in its most recent three-month period, while today house builder Taylor Wimpey said it was seeing a sharp increase in the cost of building materials, especially timber and steel.

The concern is that higher inflation will hamper growth, as rising prices may restrict consumer demand for products and services, and could force the Bank of England to hike interest rates sooner than expected. 

There are also fears that higher inflation will hike the cost of servicing Britain's £2.2trillion debt pile. 

Members of the monetary policy committee are expected to keep rates on hold when they meet tomorrow, despite consumer price inflation rising from 0.7 per cent to 2.5 per cent this year and forecasts of CPI hitting 4 per cent early next year. 

They are also expected to keep printing money until its bond-purchasing programme, or QE, reaches £895billion in December.

That's despite some members of the MPC fear the programme may cause the booming economy to overheat, including Michael Saunders and Dave Ramsden.

Rate decision: The Bank of England is not expected to hike rates at its meeting tomorrow

'Probably the clincher for the central bank is the highly asymmetric nature of its firepower,' said Laith Khalaf, head of investment analysis at AJ Bell.

'With interest rates at historic lows, and £895billion of QE on the books, the Bank has plenty of ammunition to fight inflation if required.

'If it needs to stimulate the economy on the other hand, it’s got hardly anything left in the locker. For the Bank of England, it therefore makes sense to err on the side of stoking inflation rather than risk undermining the economy.'

But some think that the spectre of soaring consumer prices is likely to push that decision forward, with banking giant HSBC predicting hikes as early as mid-2022, earlier than in late 2023 or early 2024 as widely expected.     

The key services sector, which makes up around 80 per cent of the UK economy, has already seen a slowdown in growth.

The latest IHS Markit/CIPS UK Services PMI index declined to 59.6 in July, down from June's 62.4. Any reading above 50 indicates growth, but its the weakest since March. 

The latest IHS Markit/CIPS UK Services PMI index declined to 59.6 in July, down from June's 62.4. Any reading above 50 indicates growth, but its the weakest since March.

The majority of the firms polled expect growth to continue, but the overall level of optimism has slipped, with some reflecting that the peak of the recovery has passed. 

'We suspect the best of the post-pandemic recovery could be behind us, especially if higher leisure and hospitality costs diminish appetite for consumer spending,' said Duncan Brock, group director at the Chartered Institute of Procurement & Supply.

Services firms are also lamenting shortage of stuff and supplies, both of which are holding back growth, along with a a slowdown in pent-up demand built during the pandemic.

'More businesses are experiencing growth constraints from supply shortages of labour and materials, while on the demand side we've already seen the peak phase of pent up consumer spending,' said Tim Moore, economics Director at IHS Markit, which compiles the PMI survey. 

The EY ITEM Club said they were cautious about reading too much into the PMI figures 'given the survey has tended to overstate price pressures in the past'.

It still expects inflation to rocket this year, hitting around 3.5 per cent in late 2021.

'But the EY ITEM Club remains confident that this rise will prove transitory and expects the majority of the MPC to take a similar view at tomorrow’s meeting,' it added.

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