Spending diminishes as rising interest rates impede UK economic activity

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According to a highly regarded survey, UK economic activity experienced a significant slowdown in July. The rise in interest rates impacted consumer spending, and the manufacturing industry faced further decline.

The flash UK PMI services output index, which measures activity in the sector, reached a six-month low of 51.3, as revealed in the latest data release on Monday.

Simultaneously, the manufacturing output index hit a seven-month low of 46.5, indicating contraction in the majority of businesses. Consequently, the composite index, which combines both sectors, dropped to a seven-month low of 50.7, down from 52.8 in June.

The data suggests that the UK economy has nearly reached a point of stagnation, according to Chris Williamson, chief business economist at S&P Global Market Intelligence. He attributed this to rising interest rates and the increasing cost of living, affecting households. Manufacturers are also cutting production due to a significant downturn in orders from both domestic and export markets.

A similar trend was observed in the HCOB flash eurozone composite PMI, which hit an eight-month low. July saw a sharper than expected slowdown in services and a steeper decline in manufacturing.

The UK survey coincided with a period of rising mortgage rates, driven by persistently high levels of inflation and wage growth. As a result, the Bank of England raised its benchmark rate to a 15-year high of 5% in June.

Although the survey does not fully reflect the more positive data on UK inflation published last week, which has led investors to revise their expectations for interest rate peaks, the pound fell to a two-week low against the dollar.

Despite this, John Glen, chief economist at Cips, highlighted that higher borrowing costs are the new normal, and the private sector is aware of this. The rise in interest rates has long-lasting effects on new orders and spending plans.

Economist Thomas Pugh at RSM UK emphasized that the economy is starting to struggle under the weight of the surge in interest rates and exceptionally high inflation.

Samuel Tombs from consultancy Pantheon Macroeconomics added that the survey results strengthen the case for the Bank of England to halt interest rate hikes soon. Instead, a 0.25 percentage point increase next month should be considered rather than a 0.5 percentage point rise.

Survey responses from service sector companies indicated that a weakening property market has dampened activity, and both businesses and consumers are cutting back on discretionary spending.

Manufacturers mentioned that the downturn in European markets has impacted demand for new orders. However, they have been able to maintain output levels by reducing backlogs of work and easily hiring staff who were previously in short supply.

There are signs of inflationary pressures easing, as companies reported slower increases in both costs and selling prices since early 2021.

Nevertheless, service sector companies are passing on higher wage costs to customers, which further validates the Bank of England’s concerns about a tight labor market fueling persistent inflation.