April 5, 2011 / 8:45 AM / 9 years ago

Services PMI jump boosts May rate hike view

LONDON (Reuters) - The service sector unexpectedly picked up fresh momentum in March to grow at its fastest pace in over a year, pointing to solid first-quarter GDP growth and making a May Bank of England rate rise more likely.

However, the data is very unlikely to be enough to tip wavering Bank policymakers into supporting a rate hike when they take their latest decision on Thursday, as they may worry this reading was a blip and want to see it replicated in first-quarter gross domestic product data later this month.

The Markit/CIPS services PMI index, a measure of activity growth as reported by purchasing managers, surged to a 13-month high of 57.1 in March from an unrevised 52.6 in February, beating even the most optimistic analyst’s forecast.

Sterling strengthened by more than half a cent against the dollar and gilt futures extended losses to hit a session low, underperforming German government bonds, as investors priced in a greater chance of an early Bank of England rate rise.

“When you look at where the Bank has typically raised interest rates in the past, the average level of the PMI is not that much different to where it stands right now, so it is consistent with higher rates,” said Deutsche Bank economist George Buckley.

Short sterling futures fell sharply to price in the highest expected future interest rates for three weeks, and overnight rate futures now pencil in more than a 70 percent chance of a May rate rise.

There is a question mark over the sustainability of the increase, however, as some firms reported benefiting from a spurt of public spending in March, the end of the last fiscal year before government spending cuts begin in earnest.

The 4.5 point rise in the index is the second-biggest increase since the survey started in 1996, and was only exceeded in January this year, when activity rebounded strongly after contracting due to December’s unusually heavy snow.

Data company Markit said that based on March’s figures it now believed British GDP grew 0.8 percent in the first quarter of the year, up from a 0.5 percent estimate after February’s PMI data for the services, manufacturing and construction sectors.

KEY FOR RATE MOVE

The strength of first quarter GDP is seen by most economists as the key to whether the Bank of England raises interest rates in May from a record low of 0.5 percent.

Three of the nine members of the Bank’s Monetary Policy Committee supported a rate rise in March, but the others worried that the fourth quarter’s shock GDP contraction could mark the start of an extended period of sub-par growth.

“At face value today’s data modestly boosts the case of the ‘hawks’ as it suggests the economy is returning to decent growth after the disruption from the weather in December,” said National Australia Bank economist David Tinsley.

“But equally, there’s plenty of data around for more dovish members to argue that the March PMI is probably a blip which will at least partly be reversed.”

Economists contrasted the strength of the PMI survey with the weaker picture painted by a quarterly survey from the British Chambers of Commerce released earlier on Tuesday.

“The detail of the survey was less encouraging than the headline figure — business expectations actually fell,” said Capital Economics’ Vicky Redwood. “Other news on the recovery, particularly on the consumer sector, has been much worse.”

BUSINESSES CAUTIOUS

The Markit/CIPS survey does not include state-provided services or the beleaguered retail sector. However, earlier on Tuesday books, music and DVD retailer HMV issued its third profit warning in three months.

Some firms reported a boost to business from public sector bodies using up their budgets before the end of the fiscal year — money which is unlikely to be so readily available in future as a four-year programme of roughly 20 percent spending cuts takes effect across most government departments.

“Service providers remain very cautious about expanding headcounts in the face of numerous economic headwinds,” said Markit economist Paul Smith.

“The degree of confidence regarding prospects for the year ahead slipped lower, and cost pressures remained elevated, leading to doubts over whether the rate of services growth seen in March can be sustained in the coming months.”

The survey’s new business index rose to 55.6 from 53.4, its highest level since March 2010. The amount of outstanding business increased for the first time since September 2007, and firms hired more people for the first time since June last year.

Personal services, such as hairdressers, were the fastest growing segment. But more of the index rise was driven by the business services component, which includes firms that rent machinery, conduct research and development or otherwise benefit from growth in Britain’s export-led manufacturing industry.

Editing by Catherine Evans/Ruth Pitchford

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