Purchasing managers' surveys head up UK economic week starting 29 February

Manufacturing purchasing managers' survey for February

The manufacturing purchasing managers’ survey (out Tuesday) is likely to show slower overall expansion in February. Specifically, we expect the manufacturing purchasing managers’ index (PMI) to fall back to 52.3 in February, after rising to 52.9 in January from 52.1 in December. This would be modestly above the 50.0 level that indicates flat activity. It is notable that the manufacturing PMI has largely portrayed a less weak picture of manufacturing activity than the hard data from the Office for National Statistics.

The Confederation of British Industry (CBI) has already released both its monthly industrial trends surveys for February, which were weaker overall. Specifically, the CBI’s total orders balance edged down to a four-month low of -17% in February, from -15% in January and -7% in December. Furthermore, February’s level of -17% was only just above the 28-month low of -18% in October. February’s dip in orders appears to have been primarily due to a softening in domestic demand as the export orders balance actually improved to -19% from -22% in January. This may have been helped by a weaker pound, although the upside for export orders is clearly being limited by muted global economic activity. The balance of manufacturers expecting to increase output over the next three months was actually fairly resilient in February, as it only dipped to +11% after improving to a five-month high of +14% in January from -5% in December and -6% in November. Meanwhile, a flat balance of zero manufacturers said that they had increased their output over the past three months. Finally, the survey showed that 3% of manufacturers expects to cut their domestic prices over the next three months; this was the highest balance looking to cut prices since October.

The latest hard data show that manufacturing output was flat in the fourth quarter of 2015, after contracting in both the third (0.4% quarter on quarter) and second (0.6% quarter on quarter) quarters. However, manufacturers saw output fall 0.2% month on month (m/m) in December, which was a third successive drop and caused it to be down 1.7% year on year (y/y). Furthermore, 8 of the 13 manufacturing sub-sectors saw output drop m/m in December. On a more positive note, the purchasing managers reported improved manufacturing activity in January.

There has seemingly been little respite for UK manufacturers in 2016 after a very difficult 2015, although they do have some positives to cling to – notably sterling’s sharp weakening, which should help foreign orders. Very low oil and commodity prices should also increase their ability to price competitively to try and gain business. Of course, sterling’s weakness could end up pushing up imported input prices appreciably.

However, manufacturers will be concerned by the current increasingly fraught global economic outlook. While the main concern has been centred on China and emerging markets, there are currently mounting worries over the prospects for growth in the developed countries amid heightened financial-market turmoil.

On the domestic-demand front, the outlook for manufactured consumer goods looks reasonable given still relatively decent purchasing power and high, rising employment. Prospects on the capital-goods front currently look somewhat uncertain, particularly given June’s looming referendum on EU membership. Manufacturers will be hoping that demand for capital goods can benefit from companies’ overall healthy cash positions, decent profitability, and relatively favorable lending conditions. There may be a growing need for some companies to invest to add capacity over the coming months as slack in the economy diminishes, while a tighter labour market and the introduction of the National Living Wage may also encourage increased investment aimed at saving labour. However, manufacturers will be concerned that uncertainty over the global economic outlook and also over June’s UK referendum on EU membership will result in companies becoming more cautious in their investment. IHS believes there would be several significant, immediate, and medium-term repercussions for the UK economy from a vote for a British exit regardless of whether or not the United Kingdom would be better off in the long run outside the European Union. In particular, we think there would be a hit to business confidence and investment from heightened uncertainty and concerns.

Construction purchasing managers' survey for February

The construction purchasing managers’ survey for February (out on Wednesday) is expected to show limited improvement after a markedly weaker survey in January. Specifically, we forecast the purchasing managers’ construction business activity index to have moved back up to 56.0 in February, after falling to a nine-month low of 55.0 in January from 57.8 in December.

While January’s reading of 55.0 was still clearly above the 50.0 level that is meant to indicate flat activity, it was well below the overall average of 57.6 in 2015, which was down from an average of 61.8 in 2014. A marked slowdown in house building in January (to the second-weakest level after November since June 2013) reported by the purchasing managers will have been particularly disappointing for the government, which is currently prioritising the sector to deal with the serious housing shortage in the United Kingdom and enacting supportive measures. Additionally, commercial activity slowed appreciably to a seven-month low in January. There was a modest pick-up in civil-engineering activity in January after it had seen marginal contraction in December, although it remained the weakest-performing sector. Adding to the generally disappointing news, January saw a slowdown in new orders growth, employment, and confidence (to a 13-month low). There were indications from construction companies that clients were more cautious about the outlook.

Even though the survey evidence was weaker for January, it still clearly pointed to services expansion. In contrast, hard data from the Office for National Statistics show that construction output contracted 0.4% quarter on quarter (q/q) in the fourth quarter of 2015 after a drop of 1.7% q/q in the third quarter. Construction output actually saw a much-needed decent jump of 1.5% m/m in December after a recent stream of disappointing performances. Indeed, construction output had previously fallen 1.1% in November and increased a modest 0.4% in October. It should be noted that considerable concerns remain about the quality of the hard construction data.

There are some positives for the construction sector, but it is clearly vulnerable to confidence among clients being pressured by heightened UK and global economic uncertainties. The looming 23 June referendum on UK membership in the European Union adds to these uncertainties, especially given the tightness of opinion polls.

On the positive side, there is increasing government support for house building (which needs to see prolonged decent expansion to make genuine inroads into the United Kingdom's acute housing shortage) while buyer interest in houses is likely to be supported over the coming months by relatively favorable fundamentals. In November’s Autumn Statement, the chancellor announced plans to double the housing budget to over GBP2 billion a year and to build 400,000 new affordable homes by the end of the decade. Additionally, the government has announced measures aimed at speeding up the planning system and reducing the obstacles to building new houses.

However, there have been concerns raised about the construction sector's ability to build significantly more houses. The purchasing managers have cited “shortages in key materials, supply-chain capacity, and skilled capability”. Consequently, many firms have been forced to use more expensive contractors. In addition, the Bank of England’s regional agents reported in their February survey of business conditions that “some house builders had become more cautious about prospects, partly reflecting concern over a lack of suitably skilled staff and rising costs.”

On an encouraging note, the purchasing managers reported a “sustained upturn in infrastructure-related contracts” in January. The construction sector will also benefit from repair and replacement work resulting from the damage caused by the major flooding in December–January. Low interest rates and weak commodity prices are also helpful to the construction sector.

Service sectorpurchasing managers' survey for February

We expect the purchasing managers' survey (out Thursday) to show slightly slower but still solid expansion in the services sector in February. Specifically, we expect the business activity index to have edged down to 55.2 in February from 55.6 in January and a four-month high of 55.9 in November 2015. The index had earlier recovered to November’s level of 55.9 from 54.9 in October and 53.3 in September (the lowest level since April 2013). A reading of 55.2 in February would be markedly above the 50.0 level that points to flat activity and also slightly above its lifetime (1996–2015) average of 55.2. However, it would be below the overall average of 56.7 in 2015.

Most elements of the services survey were reasonably solid in January, which suggests that services activity should have held up pretty well in February. In particular, incoming new business growth in the services sector improved to a six-month high in January. In addition, employment growth in the sector improved to a three-month high. However, outstanding business edged lower. The main disappointment in the survey was that business expectations dipped to a three-year low in January, although they were still at a decent level. This was reported to reflect concerns about the global economic situation, stock-market turmoil, the UK referendum on EU membership, and the cost impact of the introduction of the National Living Wage in April.

Additionally, the February survey of the Bank of England’s regional agents was relatively upbeat. It reported that “turnover growth had been firm overall, although remained somewhat stronger for professional and financial services than for other companies”. However, the agents did report that “consumer services growth had eased a little”.

Obviously how well the services sector performs is critical to UK growth prospects. In the fourth quarter of 2015, GDP growth of 0.5% quarter on quarter (q/q) was entirely reliant on services output, which expanded by a healthy 0.7% q/q. Fourth-quarter services-sector growth was led by distribution, hotels, and catering (up 1.4% q/q and 4.6% year on year (y/y)), while there was also healthy q/q expansion in the business, services, and finance sector (up 0.7% q/q and 1.8% y/y) and in the transportation and communications sector (up 0.9% q/q and 3.7% y/y). Output was up 0.2% q/q and 0.5% y/y in government and other services.

House prices in February and mortgage approvals in January

We expect the Bank of England to report on Monday that mortgage approvals for house purchases rose to a two-year high of 75,000 in January 2016 from 70,424 in November, 69,933 in October, and 69,212 in September. The British Bankers Association (BBA) has already reported mortgage approvals climbing markedly in December to be at a 23-month high. The BBA indicated that mortgage activity is currently being lifted appreciably by buy-to-let investors and second-home buyers looking to make a purchase before April’s rise in Stamp Duty for the sectors. Significantly, the latest survey from the Royal Institution of Chartered Surveyors (RICS) indicated that the increase in house buyer enquiries accelerated for a 2nd successive month in January, when they were up for a 10th month in all. Furthermore, agreed house sales rose to a 21-month high in January. The RICS indicated that this was significantly influenced by increased buy-to-let activity.

Meanwhile, we expect the Nationwide lender to report that house prices rose 0.6% month on month (m/m)in February, which would push the annual rate of increase up to a nine-month high of 5.0% from 4.4% in January and a six-month low of 3.2% in August. House prices rose 0.3% m/m on the Nationwide’s measure in January after an increase of 0.8% in December.

Additionally, the Halifax lender is expected to report during the week that house prices rose by 0.2% m/m in February, which would send the annual increase up to 10.4% in the three months to February (the highest since mid-2007). The Halifax data have been much stronger than the Nationwide and other studies, with prices reported to have jumped 1.7% m/m in January after an increase of 2.0% in December. Of course, there is the possibility that there was some correction in house prices in February after the large overall December/January increases. The contrast between the Halifax and Nationwide data and the monthly volatility in the data highlight the importance of not pinning too much weight on one particular house price survey or measure, but to look at the overall picture.

Based on an overview of surveys, we expect house prices to rise by around 6–7% over 2016 amid healthy buyer interest (which could well be fuelled by increased expectations that interest rates will not rise this year) and a relative shortage of properties. The current boost to housing-market activity coming from buy-to-let investors and second-home buyers looking to beat the April rise in Stamp Duty could well exert upward pressure on house prices in the near term. Post April, this move may modestly dilute housing-market activity and upward pressure on prices.

Buyer interest seems likely to be supported by largely helpful fundamentals, notably including high and rising employment, decent consumer purchasing power, relatively elevated consumer confidence, and ongoing very low mortgage interest rates. Indeed, the markedly increased likelihood that interest rates will not rise during 2016 could very well give a boost to housing-market activity. We also believe there will be some pickup in earnings growth as 2016 progresses after its recent relapse. Meanwhile, the limited supply of houses has provided appreciable support to house prices – and will likely continue to do so despite some recent signs that more houses have been coming onto the market. While the latest RICS survey reported that new construction rose for a second month running in December and at an increased rate, it was only the third increase in 18 months and average stocks of properties per surveyor were only just above the recent survey low.

Nevertheless, the upside for house prices is expected to be constrained by more stretched ratios of house prices to earnings and tighter checking of prospective mortgage borrowers by lenders. According to the Halifax, the ratios of house prices to earnings rose to 5.69 in January from 5.60 in December, 5.47 in November, and 5.10 at the end of 2014, taking it to its highest level since October 2007. This is well above the long-term (1983–2016) average of 4.15. Furthermore, there is the possibility that earnings growth will be muted in 2016 (partly because of employers using prolonged low inflation as a reason to limit pay awards).

A potential major downside risk to housing-market activity and prices comes from the vote on EU membership on 23 June. A vote for a British exit would be liable to see a marked hit to UK economic activity over the rest of 2016 and in 2017 amid heightened uncertainties, which would likely weigh down heavily on the housing market.