PMI services data should allay any fears that we are in a double dip

By Andrew Goodwin, senior economic advisor to the Ernst & Young ITEM Club

This week's PMI results point to a strong rebound in GDP growth in Q1, but the two-speed economy continues.

Developments do not justify the MPC abandoning its current policy stance.

“The strong January rebound should put an end to any fears that we are in the midst of a double-dip. Though the results in January were no doubt boosted by the catch up effect, and the balances are therefore likely to slip a little over the next couple of months, averaging the December and January results suggests a steady, but unspectacular, pace of underlying activity.

“Indeed, while the service sector has returned to growth, it is noticeable that it lags some way behind the pace of recovery achieved by the manufacturing sector. Admittedly manufacturing output fell steeper during the recession and therefore has further to catch up, but this does represent a complete turnaround from the two-speed economy we had become accustomed to before the financial crisis.

“It is clear now that the December weakness was solely due to the disruption caused by the snow and this week's three PMI surveys imply very strong GDP growth for Q1 after the surprise Q4 decline.

“Delving deeper into the detail, the results are a bit of a mixed bag. The gradual improvement in confidence about the twelve-month outlook is a positive, as it suggests that firms will continue to release funds for investment.

However, the continued decline in employment is a disappointment - given that the service sector accounts for such a large proportion of total employment, and that the pace of public sector job cuts is accelerating, this suggests that unemployment will continue to edge upwards over the coming months.

“The survey reports similar price pressures to the manufacturing survey, which will ramp up the tension at next week's MPC meeting. However, all of the pressure is coming from factors such as VAT and commodities and these are only likely to be an issue for the current year. There is still no evidence of any pick up in underlying inflationary pressures and, with this survey reporting further job losses in private services, the fragility of the labour market is likely to prevent this from happening. Though the debate will be getting increasingly fraught, we don't see how developments over the past few months could justify the majority of the MPC abandoning their long-held position that inflation will move back below target once the temporary factors fall away.