“High interest rates continue to cast a shadow over the UK economy" - S&P Global.

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Pound Sterling exchange rates fell widely in midweek trade after respondents to S&P Global surveys cited high interest rates and other headwinds for an August softening of business conditions in the services industry that has so far underpinned the domestic economy with possible implications for Bank of England (BoE) interest rates.

August's survey results cited borrowing costs and other pressures on corporate and household incomes for a "marginal" decline of activity in the breadwinning services sector as well as a "sharp and accelerated" decline of output from the manufacturing industry.

“High interest rates continue to cast a shadow over the UK economy, creating a lull in new orders, stunting output, and ensuring prospects for the private sector remain uncertain," says John Glen, chief economist at the Chartered Institute for Purchasing and Supply, when announcing the survey results.

Activity fell as a second decline in new orders for private firms deepened an earlier downturn in the manufacturing sector while also impacting the services sector with knock-on implications for employment and company earnings expectations of the year ahead.

Some companies turned to backlogs of unfinished work to keep busy for a fourth month in August with "excess capacity" prompting more job losses in manufacturing while leading hiring in the services industry to fall back to levels last seen in March.

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Above: Interbank reference rates for selected Sterling pairs at midday Wednesday. Source: Netdania.

August's results pushed the numerical S&P index measuring services sector business conditions below the 50.0 level for the first time since November, which matters because any index value below 50.0 is typically interpreted as an indicator of recession.

Index values for both manufacturing and services industries now sit below the 50.0 level though the surveys do have a history of overstating and understating changes in activity, and August's edition of the surveys wasn't all bad news.

More positively, average cost burdens rose at their slowest since February 2021 despite reported wage increases lifting input cost price inflation, while output prices charged by companies fell in what is potentially a harbinger of further disinflation in the pipeline.

"That echoes what we’ve seen in various other surveys too," says James Smith, a developed markets economist at ING, in response to Wednesday's surveys.

"Remember that much of the impact of past rate hikes is still to feed through, given the heavily-fixed nature of the UK’s mortgage market," he adds.

Source: Pantheon Macroeconomics.

Further declines in inflation would likely be welcomed by the Bank of England (BoE) and could be supportive of economic activity but the outlook is clouded by uncertainty over the full effects of a near-record increase in interest rates so far and almost universal forecasts for further increases ahead.

"We doubt the Committee would raise rates to the 6% level priced-in by markets. But the MPC likely will not be willing to take any risks with the inflation outlook and probably won't have seen enough hard evidence by their meeting next month to press the stop button," says Samuel Tombs, chief UK economist at Pantheon Macroeconomics.

The UK economy grew by an average of 0.2% in the opening quarters this year while the BoE projected an unchanged rate of expansion for the second half this month but the effect of earlier increases in interest rates is likely to be more fully felt with greater numbers of mortgaged households rolling onto sharply increased rates as the months go by.

Much has been made in and around financial markets about the recent high single-digit percentage increases in wages and their possible implications for inflation if interest rates are raised further in order to reduce demand in the economy by an equivalent amount, but the BoE and other factors have already potentially gone further than that.

Bank Rate was raised from 0.1% in December 2021 to 5.25% in August, imposing heavy additional costs on mortgage borrowers, while the average household energy bill was also around £600 higher in August this year when compared with the average £1,339 tariff level prevailing in the opening quarter of 2022.

Source: Pantheon Macroeconomics.