British economy on track for sharp contraction in first quarter but optimism is back

Eurozone confidence drops on new restrictions and poor vaccination drive

People past closed shops in England. IHS Markit's Composite PMI dropped to its lowest reading since May in January, tied in with a stricter lockdown in England and more stringent restrictions in Scotland and Wales. ReutersShow less

Britain’s economy is on track for a sharp contraction in the first quarter of this year, but services companies are confident of a recovery on vaccination hopes, according to IHS Markit.

The final version of the IHS Markit/CIPS UK Composite Purchasing Managers' Index (PMI) – which covers services businesses and manufacturers – fell to 41.2 in January from 50.4 in December, with any figure below 50 indicating a contraction.

While this was the index’s lowest reading since May, it tied in with a stricter lockdown in England and more stringent restrictions in Scotland and Wales. It was also far above a reading last spring during Britain’s first shutdown, when it slumped to 13.8.

"While the UK economy is on course to contract sharply during the first quarter of 2021, businesses remain confident that pent-up demand and an easing of pandemic restrictions will provide a springboard to recovery later this year," Tim Moore, economics director at IHS Markit, said.

Britain’s vaccination effort has so far covered 14.5 per cent of the population, according to Capital Economics, indicating that the government’s goal to administer about 14 million first doses by mid- to late-February will be met comfortably.

“We remain more optimistic than most that, provided vaccines are resistant to new virus strains and policymakers don’t tighten fiscal policy prematurely, GDP [gross domestic product] will return to its pre-crisis peak by Q1 2022,” said Capital Economics.

While the services PMI dropped to 39.5 in January from 49.4 in December – the fastest reduction in business activity in the sector for eight months - Britain’s speedy delivery of the vaccine has helped to boost optimism among services firms to its highest since May 2014.

This was in contrast to falling confidence in the eurozone, where the vaccination drive has been slow, and renewed restrictions to curb the spread of coronavirus have hit the bloc’s services sector.

The composite PMI fell to 47.8 from December's 49.1, held up from falling further by robust factory growth, and the PMI covering the services industry fell to 45.4 in January from 46.4 in December.

"Today's data support our view that the eurozone economy has started the new year on the back foot," said Melanie Debono, a Europe economist at Capital Economics.

"With the vaccine rollout stalling already and new virus strains circulating, the risks to our forecasts for a recovery to start near the end of Q2 are firmly to the downside."

Meanwhile, eurozone inflation jumped in January, with consumer prices rising 0.9 per cent on the year - the first gain in six months.

A measure that excludes volatile items such as food and energy surged to 1.4 per cent, the highest in more than five years.

“The marked increase came mainly from the sharp rise in German headline inflation due to the temporary VAT cut reversal," said Maddalena Martini, a eurozone economist at Oxford Economics.

Economists said the readings would be welcomed by European Central Bank policymakers, as they suggest the lender will not see a need to change its course in supporting the economy.

“We see little implication for the ECB as it should have already considered these factors and have accounted for them in its baseline forecast," said Ms Martini.

"Moreover, underlying inflation dynamics outside of Germany are significantly weaker, so the ample monetary support remains justified."

The ECB kept interest rates and its stimulus package unchanged in January, holding its pandemic bond-buying programme at €1.85 trillion ($2.22tn), following a €500bn boost in December.