UPDATE 1-UK services sector slows in June, but Q2 prospects still bright

Thu Jul 3, 2014 8:48am EDT

Related Topics

* UK services slows more than forecast in June, but robust

* PMIs suggest economy grew at least as fast as Q1 in Q2

* Data reinforces case for interest rate rise this year

* For related graphic: link.reuters.com/nap74s (Updates throughout)

By Ana Nicolaci da Costa

LONDON, July 3 (Reuters) - Growth in Britain's dominant services industry slowed more than expected in June, but the economy as a whole appears to have expanded robustly over the past three months, a survey showed on Thursday.

British government bonds outperformed and sterling eased off recent near-six-year highs after the monthly services purchasing managers' index (PMI) dropped to a three-month low of 57.7 -having hit its highest so far this year in May.

But economists said the numbers remained well above long-run averages and could point to a pick-up in growth in the second quarter from the first three months of the year.

The data comes after strong manufacturing and construction surveys this week reinforced bets that the Bank of England will raise interest rates in 2014.

"Alongside ... an ongoing surge in construction and the largest quarterly rise in manufacturing output for 20 years, the services PMI confirms that the UK economy is firing on all cylinders," said Chris Williamson, chief economist at Markit, which compiles the surveys.

"The persistent strength signalled by the PMI surveys raises the likelihood of policymakers deciding that a pre-emptive rise in interest rates later this year is warranted."

Britain's economy posted its fastest annual growth since 2007 in the first quarter, as record low interest rates, robust consumer demand and a strengthening housing market fuelled a surprisingly rapid recovery.

The BoE has indicated that a rate rise could come this year, though it has also said that more slack needs to be absorbed, particularly in the labour market, before that happens.

BoE Governor Mark Carney has said that to date there have been few signs that growth will slow appreciably in the second half of the year, in contrast to what the central bank had forecast in May.

MIXED MESSAGES?

Thursday's survey offered mixed messages as to whether services may be starting to cool. As well as the fall in the headline index, business expectations in the services sector were at seven-month lows.

But new business volumes saw their sharpest rise in six months and the industry created jobs at a record pace, with the survey's employment index rising to a record high of 58.8. That suggests wage inflation may finally start to rise, as the pool of spare workers gets depleted.

Separate surveys this week showed British manufacturing activity expanded at its fastest rate in seven months in June and construction grew at its quickest annual pace in four months.

A composite index combining PMIs for manufacturing, construction and services fell to a three-month low of 58.4 in June from 59.1 in May.

But Capital Economics said the average level of the index over the second quarter as a whole was still higher than it was in the first quarter and was consistent with a quarterly expansion in gross domestic product of well over 1 percent.

Markit said it believed the composite PMI pointed to growth of 0.8 percent, the same as in the first quarter.

The prospect of fast growth in the second quarter has supported the view that interest rates might rise this year, after Carney said last month markets were underestimating the likelihood of that happening.

The BoE has been reluctant to act pre-emptively for fear of derailing the recovery and as inflation pressures remained subdued. As recently as May, Carney had indicated a rate rise would only take place in the second quarter of 2015.

"The UK is experiencing a balanced strong expansion that should result in a rate hike in November this year," Rob Wood, chief UK economist at Berenberg said. (Graphic by Vincent Flasseur; Editing by Larry King)

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