UK services sector returns to growth in May, PMI survey shows

The UK's services sector rebounded in May, with the S&P Global PMI rising to 50.9 from April's 49.0, driven by receding concerns over U.S. tariffs and improved global financial markets; however, businesses continue to face pressure from rising labor costs due to minimum wage increases and higher national insurance contributions, leading to workforce reductions and slower price increases, which may ease concerns for the Bank of England regarding wage-driven inflation.

Analysis

The UK services sector demonstrated a return to modest growth in May, with the S&P Global Purchasing Managers’ Index (PMI) rising to 50.9 from April's contractionary reading of 49.0, surpassing the flash estimate of 50.2. This rebound was reportedly driven by diminished concerns regarding U.S. tariffs, an improvement in global financial market conditions, and increased client confidence, leading to a significant reversal of April's sharp decline in export orders and a slower contraction in overall new orders. Consequently, expectations for future output reached their highest level since October. Despite this positive monthly development and a stronger-than-anticipated 0.7% GDP growth in Q1, the Bank of England maintains a cautious outlook, anticipating a slowdown, partly influenced by downbeat business surveys. Persistent pressure from labor costs, stemming from a nearly 7% rise in the minimum wage and higher employers’ national insurance contributions, continues to affect businesses, particularly those employing numerous lower-paid staff. This has contributed to workforce reductions for eight consecutive months, although May saw the slowest pace of decline in six months. While input costs for firms remained elevated, primarily due to labor expenses, the rate of increase in prices charged to customers slowed to a seven-month low, attributed to heightened competitive pressures. This moderation in output price inflation, despite robust wage growth, may alleviate some of the Bank of England's concerns about persistent inflationary pressures hindering its ability to return inflation to the 2% target.

Key Decisions for Investors

• Investors should closely monitor subsequent UK economic indicators to ascertain the durability of the service sector's recovery, particularly given the previous month's contraction and the Bank of England's cautious stance on future growth.
• The persistent upward pressure on labor costs warrants careful consideration for its potential impact on profit margins within the UK service sector, especially for companies with significant exposure to minimum wage employees.
• The observed moderation in output price inflation, despite ongoing wage growth, could influence Bank of England monetary policy expectations, potentially leading to a less aggressive stance on interest rate hikes, which would have implications for UK fixed income and currency markets.