UK factories have reduced production and investment at the start of the new year. This is a result of escalating tensions in the Red Sea, which is negatively affecting manufacturers and preventing them from ending a period of contraction that has lasted nearly a year.
Factory owners reported import price rises and delays to exports that forced them to reduce output in January for an 11th consecutive month, according to a leading business survey.
However, the UK’s dominant services sector expanded by more than expected, improving the overall outlook for the British economy.
Investors responded to the survey by increasing the value of the pound because they believed that interest rates would remain high for a longer period of time.
The Bank of England will have a meeting next week to discuss its monetary policy. They might suggest that the first cut to interest rates should be delayed due to inflationary pressures caused by stronger growth.
The pound climbed to $1.27 and interest rate futures showed investors continued to expect four quarter-point cuts in 2024, but with less conviction than earlier in the day.
Chris Williamson, chief business economist of S&P Global Market Intelligence, says that business activity and confidence are being fueled by hopes of faster economic growth in 2024. This is connected to the anticipation of decreasing inflation and lower interest rates.
“However, the surprising strength of growth in January, which has exceeded forecasts, may deter the Bank of England from cutting interest rates as soon as many are expecting, especially as supply disruptions in the Red Sea are reigniting inflation in the manufacturing sector.”
The preliminary reading for the S&P Global/CIPS UK composite PMI, which spans both services and manufacturing companies, rose to 52.5 in January, its highest level in seven months and up from December’s final figure of 52.1. A reading above 50 indicates expansion.
Economists polled by Reuters had forecast a slightly smaller increase to 52.2.
The services index increased to 53.8, compensating for a 47.3 figure in the manufacturing sector and a three-month drop to 44.9 in manufacturing output.
Manufacturers faced challenges at the beginning of 2024, according to a survey by the CBI. Total new orders decreased at the fastest rate since July 2020. The index balance dropped from +2 in October to -13 in the three months leading up to January.
Shipping costs had fallen steeply from early December, according to the Baltic Dry index which tracks the cost of shipping bulk dry goods and is a leading economic indicator. However, that has risen sharply in recent weeks after attacks by Houthi rebels on container ships passing through the Red Sea.
Export salesremained a weak spot, said Williamson, with a sustained decline in the manufacturing sector offsetting modest growth in the service economy.
A survey by S&P found that lower inflation and reduced borrowing costs have improved the sentiment of UK service companies, making them more inclined to hire staff, services sector contrasts with weakness in the eurozone, where the composite PMI of 47.9 remained in negative territory in January and was fractionally below analysts’ forecasts.
“The issue for the Bank of England is that inflation is also proving sticky, and the PMI highlights the disruption in the Red Sea,” said James Smith, economist at financial services firm ING. “Today’s data adds to the case for the Bank of England to wait a little longer before cutting rates. We expect a cut in August.”