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Services inflation holds the key to August rate cut

Journalist: John Choong (Head of Markets and Research), Newspage

ended 16. July 2024

 

A cooling in services inflation as a result of the drop in the latest PMI (Purchasing Managers Index) input price rate could indicate an August rate cut.

Headline inflation via the Consumer Price Index (CPI) may have hit the Bank of England's 2% target in May, but the odds of a rate cut in August and September have been yo-yoing over the past month. This is due to the fact that services inflation remains sticky, with a huge chunk of the drop coming from lower energy prices.

Services inflation, by contrast, has been dropping at an extremely slow rate, averaging a measly 0.14% drop every month. And with services inflation currently at 5.7%, it would take another 23 months before it returns to its pre-pandemic level, assuming the current rate of disinflation.

The latest Services PMI Survey, released by S&P earlier this month, is a leading indicator for inflation. Therefore, the survey provides clues to any possible rate cuts by the Bank of England, whose Monetary Policy Committee (MPC) convenes on 1 August to decide on interest rates.

The Services PMI is divided into two categories that gauge inflation — “Output Price Inflation” and “Input Price Inflation”. In the latest survey, output price inflation increased compared to last month, possibly due to the Taylor Swift concerts boosting demand and, subsequently, prices.

However, the survey's input price inflation gauge shows the opposite. In fact, this year, the input price inflation gauge has a flawless record in predicting the month-on-month trajectory of services inflation.

The bulk of survey respondents reported a further cooling of input inflation. Thus, if this metric continues its 100% record, it would suggest that services inflation is projected to drop in June, and would help to bring the year-on-year figure down to 5.6% from 5.7%.

Regardless, in order for a rate cut in August to get the green light, headline CPI will have to come in at least or lower than the 2% rate markets are currently expecting, with core CPI coming in at least equal or lower than the 3.5% forecasted.

Taylor Swift's concerts in June may have likely ramped up demand for services such as hotels as well as recreational and cultural activities, thereby stoking inflation, but given the encouraging cooling of wage growth over the past few months, there's certainly a realistic level of hope that headline inflation can at the very least hold onto its 2% target on Wednesday.

7 responses from the Newspage community

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Justin Moy
Managing Director at EHF Mortgages
The MPC needs to stop waiting for the economy to be perfect before it acts. The MPC should act pre-emptively and not wait for the very last inflationary metric to justify the first base rate cut. The headline inflation target remains the elephant in the room, hard to ignore, but it creates a shadow over the MPC members that will inevtiably make them hide from making a positive decision for another month.
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Ben Perks
Managing Director at Orchard Financial Advisers
Although this metric has been successful, it is impossible to predict with resounding certainty. The decision on base rate is in the hands of 9 people, the majority of whom are self-serving and totally out of touch with borrower turmoil. The Monetary Policy Committee have been so slow to react that they must think the word ‘Proactive’ should only appear on the side of a gut-friendly yoghurt. Andrew Bailey has been asleep at the wheel throughout the cost of living crisis and failure to reduce Bank Rate in August will result in many people calling for his resignation.
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Graham Cox
Director at Bridging Hub
Whilst services inflation remains stubbornly high, I doubt a one-off like the economic boosting effects of Taylor Swift's UK tour are likely to factor into Andrew Bailey's thinking. And despite what the Bank of England tells us, most people's personal inflation rate is way above two percent. Particularly those on lower incomes who spend a disproportionate amount of their income on food, housing and energy. A base rate cut is long overdue to ease the cost of living crisis.
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Rohit Kohli
Director at The Mortgage Stop
With the current Monetary Policy Committee I don’t think any metric can be relied upon to give certainty of direction of travel. They were painfully slow to react when signs showed increasing inflation and they are being slow to react to when it’s falling.
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Craig Fish
Director at Lodestone Mortgages
There are only two certainties in life: death and taxes. Everything else has no guarantees, so while the gauge has a 100% record, it could still be wrong. That said, there have been calls for many months now to ease the burden on households and businesses, yet Andrew Bailey and his team have failed to sympathise by keeping rates on hold. If rates are held on 1st August, heads need to roll. This team have proven time and time again that they are behind the curve and make decisions too late. For once they need to be ahead.
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Andrew Montlake
Managing Director at Coreco
To the majority of people the recent fall in inflation is just a mythical tale and has not changed how they feel or the power of their wallets one iota. Prices are still high and the daily grind is still hard, something the Bank of England seems willing to continually ignore. It seems that the MPC never learn from past lessons and have been consistently slower to react than they should, and this time is no exception. The country is crying out for that first rate cut, which is now long overdue. If it does not come in August, and at the very latest September, there will be more than a whiff of negligence in the air. It is high time we revisit the Bank of England's targets to make them more relevant to real life today.
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Amit Patel
Adviser at Trinity Finance
After the disappointment of the Euros and a wet miserable summer we need something to cheer us all up and the MPC have the power to make this happen by voting unanimously for a reduction in base rate on 1st August.