THE UK’s economy is sick and the cheap fix of quantitative easing (QE) is being touted as the cure. The broad consensus was that yesterday’s Markit/Cips services purchasing managers’ index (PMI) was going to come in at around 54.0. It instead dropped off a small cliff, declining from 55.4 in July to 51.1 in August. This is the biggest single month drop since foot-and-mouth disease ravaged the country in 2001.
A BAD PORTENT
The PMI results reveal to the markets that the UK’s purchasing managers, making up around three quarters of UK businesses, are significantly more bearish than they were last month about their output, new orders, export orders, stock levels, delivery times, output and input prices and employment. Because it’s a leading indicator and services dominate the UK’s economy, PMI is a decent indicator of where GDP is heading. According to Jonathan Loynes, chief European economist at Capital Economics: “A composite measure of the main activity indices of the Cips reports on manufacturing, construction and services is now consistent on the basis of the past relationship with quarterly contractions in GDP of about 0.2 per cent.” As such, traders should keep an eye on Wednesday’s NIESR estimate.
QE is being posited by some as a likely consequence. Although traders will closely watch Thursday’s monetary policy committee (MPC) policy decision, there is little chance that Adam Posen – the only member currently voting for asset purchases – will be joined by many of his colleagues. David Jones of IG Markets doesn’t expect QE from the UK at the moment, but thinks it will be dictated by QE policy in the US – noting that the 20 September Fed interest rate decision will be key.
TO QE, OR NOT TO QE?
Michael Hewson of CMC Markets says: “Policymakers seem to think QE is a silver bullet for all the economy’s ills.” Hewson says it isn’t: “It will devalue sterling and drive up imported inflation, giving people less money to spend, not more.” Simon Smith, chief economist at FxPro, thinks the Bank of England (BoE) has reservations about its effectiveness. He says: “Even though the Fed has done QE2, it still only owns 17 per cent of marketable US securities, whereas the BoE owns 20 per cent of UK government paper outstanding.” He expects the BoE to wait to see the results of the Fed’s twist-style operation – selling short-dated US Treasuries, while buying long-dated US Treasuries – as this should pull UK gilts lower. Smith also notes that flattening the yield curve “could further impact on banks’ profitability – on borrowing short and lending long – not really delivering the unclogging of the financial system that it is intended to achieve.” Yet Mervyn King has repeatedly argued that money and lending would have contracted more sharply in the absence of his first dose of monetary stimulus. Traders should note he is still a believer and will be preaching to the committee for another QE miracle.