The overall level of economic activity in the UK is dominated by the services sector and here the picture is more mixed. However, a good survey barometer of the services sector is probably provided by the purchasing managers’ index which is published every month. The latest survey shows that after a dip in December, services activity returned to growth in the early months of this year (see Chart 3). The rate of growth in the services sector indicated by recent business surveys is not as strong as we saw in the period before the recession. But that should not be a surprise. The services sector is more heavily dependent on domestic consumer demand than manufacturing, and therefore the impact of higher VAT and other imported price rises may be more noticeable in the short-term. It is also worth noting that services growth was particularly strong from the mid-1990s to the mid-2000s, growing much faster than manufacturing and other sectors of the UK economy.5 With the economy rebalancing and the manufacturing sector now performing more strongly, we should not expect services growth to return to the strong rate seen before the global financial crisis. 5  The output of the UK services sector rose at an annual rate of 3.8% between 1995 and 2007, compared with 2.9% average growth across the economy as a whole over this period.
With consumer price inflation remaining high, this pattern is likely to continue through this year. Most forecasters are assuming that there will be limited upward pressure on wages from high inflation in the short-term, partly because of the downward influence of relatively high unemployment and partly because the rise in inflation is expected to be temporary. The latest consensus forecast is for average earnings growth to pick up to 3% by 2012 from the current underlying rate of increase of 2.3%. However, Income Data Services are already reporting that pay settlements have moved up to 2.8% in the private sector, pushed up by a number of pay deals linked to the Retail Prices Index. In my judgement, there are upside risks to both inflation and consumption growth from a stronger rebound in wage growth as the recovery proceeds. This is one of the reasons – though not the only one – why I believe that the current Inflation Report forecast that inflation will fall back to the 2% target is relatively optimistic. The behaviour of wages and consumption will therefore be an important influence on the outlook for both growth and inflation over the next couple of years, and this is clearly an area that the Monetary Policy Committee is monitoring closely. With imported price pressures and VAT adding to inflation in the short-term, we should not be surprised to see a squeeze on real incomes and relatively subdued consumer spending in the first half of this year.