UK interest rates increase expected after services sector activity accelerates

Purchasing manager’s index at eight-month high, bolstered by spending on AI as firms regain momentum since start of Iran war

The Bank of England is expected to raise interest rates on Thursday after a closely watched survey showed growth across the UK’s services sector leapt last month to an eight-month high, bolstered by spending on artificial intelligence.

S&P Global’s survey of the services sector in October showed businesses regained much of the momentum they lost after the start of the Iran war, but also felt the impact of a renewed spurt of input price inflation, which accelerated to a five-month high.

Officials at the Bank have become concerned about inflation after the consumer prices index (CPI) rose from 3.1% in August to 3.5% in September.

While the nine-member monetary policy committee (MPC), which sets interest rates, has been split in recent months, a majority is expected to vote on Thursday for 0.25 percentage point increase to 4%.

Tim Moore, the economics director at S&P Global Market Intelligence, said a survey of the manufacturing sector earlier this week also showed businesses facing strong price pressures.

He said: “These signals underscore the near-certainty of a Bank of England rate hike in November and collectively raise the likelihood of further Bank of England policy tightening into 2027.”

Financial markets expect three further increases in the cost of borrowing, although most City economists believe inflation is likely to peak in the spring of next year, allowing the Bank to limit the number of extra interest rate rises to one or two.

Moore said service providers indicated the fastest upturn in activity since February and “a solid rebound in new orders”.

The S&P Global services purchasing manager’s index (PMI), which gauges growth across sector, rose from 52.1 to 52.8. A reading above 50 indicates a period of expansion.

Bigger workloads prompted businesses in the services industry to take on additional staff in October, the survey found.

This ended two years of continuous job cutting across the sector, with many businesses during that period saying that they were responding to higher labour and business costs, or not replacing employees who left.

Moore said the survey suggested an “increase in economic resilience despite challenges from geopolitical tensions, elevated cost pressures and subdued consumer confidence.”

“Greater workloads were attributed to an improved pipeline of sales opportunities, particularly those linked to AI investment spending,” he added.

The sector has benefited from the demand for AI applications and software services associated with the boom in datacentre construction.

Matt Swannell, the chief economic adviser to the economic forecasters the Item Club, said official data also pointed to a surge in activity in the IT and professional services sectors.

He cautioned that growth in business-to-business services was not being matched on the high street, which has continued to be badly affected by a dip in consumer confidence.

“With at least some of that strength reflecting businesses’ rapid adoption of AI technologies, we expect pockets of strength to sustain momentum into next year. But in a two-speed economy, consumer-facing services will come under increasing pressure as households’ spending power is squeezed,” Swannell said.

He added: “An interest rate hike looks nailed on at tomorrow’s MPC meeting. And today’s data only adds to the weight of evidence.”

Moore said about four in 10 of the services sector survey panel reported an increase in their input prices, while only 1% experienced a decline.

It is unclear how much services firms will pass on higher input costs to consumers, pushing up inflation. Some members of the MPC have said they are prepared to wait for more evidence while others have indicated they will vote to quell even modest increases in prices.

Rob Wood, the chief UK economist at the consultancy Pantheon Macroeconomics, said there was a sign that services businesses were absorbing costs, but not by enough to prevent a rate rise.

The services output price balance dropped to 56.9, from 57.8 in September. “We estimate this is consistent with underlying services inflation rising about 4.1%, down from the latest official reading of 4.4% but still too high for the MPC to stand pat,” Wood said.

Meanwhile, inflation in the eurozone rose to a three-year high of 4% last month on surging energy and food costs, up from 3.8% in September. The increase makes a rate rise in December by the European Central Bank more likely after it left borrowing costs unchanged last week.