BOE Gets Big Signal U.K. Economy Is Starting to Bounce Back

(Bloomberg) -- The biggest part of the U.K. economy grew more than forecast in May, backing up the Bank of England’s view that a recent slump was temporary and keeping it on track for an interest-rate increase in the summer.

A measure of services jumped to a three-month high of 54 from 52.8, beating the reading of 53 predicted in a Bloomberg survey. Taken with manufacturing and construction, it suggests the economy is on course for growth of 0.3 to 0.4 percent this quarter, said IHS Markit, which publishes the indexes. Expansion slowed to just 0.1 percent in the first three months of the year.

The pound jumped after the report and was up 0.5 percent to $1.3379 as of 10:48 a.m. London time.

For the BOE, the latest Purchasing Managers Indexes support its view that the near-stagnation at the start of the year was largely down to bad weather. Retail sales rebounded in April and separate figures Tuesday point to another strong month in May, when Britons basked in a heat wave.

While the BOE held off raising interest rates in May as a precaution, it’s expected to act later this year. Policy maker Silvana Tenreyro said on Monday that the weakness was short-lived and the U.K. will need a gradual tightening over the next three years.

What Our Economists Say:

“The pick up in the composite PMI in May, which has been mirrored in a number of other surveys, suggests growth momentum may be reasserting itself. We expect that to be reflected in the hard data over the coming weeks, supporting the case for a rate hike in August.”

--Dan Hanson, Bloomberg Economics. For more, see the U.K. React

Investors are currently pricing about 44 percent chance of a U.K. rate increase in August. Tenreyro said is that while there’s little cost to waiting one quarter to more fully assess the economy, delaying too long is a risk. In her view, “flexibility is limited.”

“The Bank of England appears to have a preference to raise interest rates sooner rather than later based on a belief that wage growth will respond to a tight labor market, keeping inflation higher for longer,” said James Knightley, an economist at ING in London. “These data releases keep the prospect of an August rate hike firmly on the table.”

However, Knightley added that the BOE won’t follow quickly with additional tightening, given the ongoing risks. That was echoed in the Markit statement, which noted that Brexit is holding back investment and new orders are growing at the weakest pace since 2016. Confidence across the services sector dropped for the third time in four months.

“Disappointing inflows of new work suggest that growth could wane in coming months,” said Chris Williamson, Markit’s chief business economist. He agrees that a BOE move will probably come in August, but it isn’t set in stone.

“With forward-looking indicators suggesting that the economy could relapse, a rate rise is by no means assure,” he said.

©2018 Bloomberg L.P.

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