4 June 2026: The BoE Governor warns against overvaluing AI businesses

The British services sector recorded a modest decline in activity in May, as rising costs linked to the war in Iran and weakening demand weighed on business conditions, according to a survey released yesterday.

The S&P Global Purchasing Managers' Index for the sector fell to 49.3 in May from 52.7 in April. The reading marked the first contraction in output since April 2025.

However, it came in above the preliminary estimate of 47.9. The decline in services activity coincided with the OECD slightly raising its growth forecast for Britain.

The organisation increased its projection to 0.9% from the 0.7% forecast issued shortly after the outbreak of the Middle East conflict.

Despite the deterioration in services activity, the downturn indicated by the PMI survey was less severe than that seen in the Eurozone.

Survey respondents reported weaker demand from both domestic and overseas customers during May, contributing to the slowdown in business activity.

The composite PMI, which combines services and manufacturing data, was revised higher to 49.7 from a preliminary estimate of 48.5. However, the reading remained below April's level of 52.6, signalling an overall decline in private-sector activity.

While activity weakened, inflationary pressures remained strong across the services sector.

The PMI measure of input cost inflation eased slightly in May but remained at its second-highest level since December 2022, a period that followed Russia's full-scale invasion of Ukraine. Businesses reported that higher energy, fuel, and transport costs, along with rising salaries, contributed to increased operating expenses. Companies have responded by passing these costs on to customers.

The survey showed firms raised prices at the second-fastest pace in three years, only marginally below the April increase.

Tim Moore, economics director at S&P Global Market Intelligence, said ongoing concerns about inflation and geopolitical risks continued to affect sentiment. "Worries about a prolonged spike in inflationary pressures, combined with elevated geopolitical tensions and subdued demand, continued to weigh on business activity expectations in May," Moore said.

Bank of England Governor Andrew Bailey has been very active in speaking to the press recently. This marks a shift, as the Treasury Select Committee told him they were disappointed by his apparent lack of communication about the Bank's thinking on several topics.

Yesterday, he continued to warn about the dangers of a possible bubble in the valuation of firms in the AI sector. His warning comes as Anthropic, the creator of the Mythos AI model, which is claimed to be able to disrupt system security measures thought to be impregnable, was valued at nearly $1 trillion.

"If you look at something like the internet, for example, many of the companies that were pioneers in that field are not necessarily the ones that have survived to this day," Bailey told a hearing of the Economic Affairs Committee in the British House of Lords. "So, to assume that all companies today are profitable in the long run is not in line with the facts of history."

Bloomberg News quoted Bailey as saying, "The function of stock markets, for example, is to assess future earnings flows and, therefore, the future productivity gains of that entity, and they can get that wrong in several ways." He added, "There is another shock in trade, in that we are importing energy at higher prices, which, all other things being equal, will lead to higher inflation than we had anticipated."

Britain’s economic growth is forecast to fall below one per cent this year as rising unemployment and escalating energy costs linked to the Middle East conflict continue to weigh on the economy.

The Paris-based OECD said UK gross domestic product would expand by just 0.9 per cent in 2026, down from 1.4 per cent growth in 2025.

It also projected unemployment would climb to 5.5 per cent as economic conditions weaken.

The OECD said the slowdown was being driven primarily by the continuing US-Iran conflict, which has pushed oil and gas prices higher across global markets.

The pound lost ground, falling to a low of 1.3412, as a mix of weak economic data, lower growth estimates, and an escalation of the conflict in Iran weighed on the currency. It stayed near that low throughout the day, closing at 1.3417.

The story was brighter on the other side of the Atlantic, as US services-sector activity picked up in May, with businesses placing orders in advance and rebuilding inventories in anticipation of shortages and higher prices due to the war with Iran.

The Institute for Supply Management said yesterday that its non-manufacturing purchasing managers' index rose to 54.5 last month from 53.6 in April. Economists polled by Reuters had forecast the services PMI rising to 53. 8.

The services sector accounts for more than two- thirds of US economic activity. The three month US-Israel war with Iran has severely disrupted the shipping of commodities and raised the prices of goods, including energy, aluminium and fertilisers.

The rise in the services PMI mirrors an increase in manufacturing activity reported by the ISM this week.

The survey's measure of new orders received by services businesses jumped to 57. 3 from 53. 5 in April. Services sector inventories soared to 62.5 from 53.1. Business inventories have been drawn down for four straight quarters, the longest such stretch since the Great Recession. But growth in backlog orders slowed, as did exports.

The survey's measure of prices paid by businesses for inputs increased to 71. 3 from 70. 7 in the prior month, indicating that the oil price shock would continue to spill over into the services sector. Inflation increased at its fastest pace in three years in April, the Administration reported last week.

Financial markets now expect the US Federal Reserve to keep its benchmark overnight interest rate in the 3.50%- 3.75% range into next year.

The survey's measure of supplier deliveries eased to a still-high 55.2 from 56.8 in April. A reading above 50 indicates slower deliveries. The elevated reading likely contributed to the rise in the services PMI as the economy strengthens and demand increases. But in this instance, strained supply chains are driving up delivery times.

Services sector employment remained subdued. The ISM has noted an uptick in "attrition". The ISM employment gauge, however, has not been a good predictor of private services payrolls in the Labour Department's closely watched employment report.

Non-farm payrolls have posted back-to-back months of gains above 100,000. Payrolls likely increased by 85,000 jobs in May after rising 115,000 in April, a Reuters survey of economists predicted.

The unemployment rate is forecast to hold steady at 4.3%.

As if he had not already provided sufficient shocks to the global economy this year, President Donald Trump is thought to be considering fresh tariffs this time, using forced‑labour enforcement as the legal hook, and the scale is enormous.

The administration has proposed new tariffs of 10%–12.5% on goods from 60 countries, arguing that these countries have failed to prevent the export of goods made with forced labour. This follows an investigation launched after the Supreme Court struck down Trump’s earlier “reciprocal tariffs” in February.

The USTR argues that weak enforcement abroad creates an “uneven playing field” for U.S. workers.

During Kevin Warsh's swearing-in ceremony, Trump proclaimed: “Honestly, I really mean this. This is not said in any other way. I want Kevin to be totally independent. Just do your own thing and do a great job. OK?”

But just hours later, speaking to an audience at a local community college, Trump declared: “We're going to get interest rates down quickly; everybody's gonna be happy.”

It took the President virtually no time to outline his expectations for the new Fed chair. The problem is that he's placed Warsh in a no-win scenario.

The glaring issue is the inflationary effects of the war in Iran. Iran's closure of the Strait of Hormuz to virtually all commercial vessels has created the largest energy supply disruption in modern history. Fuel prices are climbing at the fastest pace in over three decades, and the adverse effects of higher prices are just beginning to be felt beyond the energy sector.

The Cleveland Fed's May inflation forecast points to prices rising at the fastest pace in three years. Warsh, who has historically leaned towards the hawkish end of the spectrum, and the FOMC aren't in any position to consider lowering interest rates quickly, or at all.

The dollar index is driven by expectations of a hawkish message from the Fed, even if rates are not hiked this month. Yesterday, it rose above its recent high, reaching 99.55, and closed at 99.54.

The European Central Bank looks set to raise its key interest rate next week, dusting off a tactic it last used in 2011 as it seeks to send a strong message on inflation at a time when the eurozone economy risks sliding into stagflation.

The conflict in the Middle East has pushed oil and natural gas prices sharply higher. That has had an immediate impact on the eurozone’s annual inflation rate, which rose to 3.2% in May from 1.9% three months earlier.

It has also hurt the eurozone’s growth prospects. The currency area’s economy was on the edge of stagnation in the first three months of the year, and surveys of businesses for April and May point to a risk of contraction in the second quarter.

The jump in inflation may prove short-lived and largely confined to energy, with demand remaining weak and workers unwilling to risk losing their jobs in search of higher pay. This is the Central Bank’s core hope during any inflationary cycle, no matter its length.

Even as the Federal Reserve and the Bank of England take their time to assess the war’s impact on longer-term price movements, the ECB appears to have seen enough.

“We can no longer look through this shock, and this is true even if the war ended today,” said Isabel Schnabel, a member of the ECB’s executive board, earlier this week.

Schnabel and other policymakers worry that the jump in energy prices will lead to second-round effects, which have become more common in recent years, even though it is fairly obvious that as their outgoings increase, workers want to receive more compensation.

ECB officials believe that by the time the hard evidence arrives, it will be too late to tame inflation. Instead, they are looking to preemptively raise borrowing costs to signal to workers and businesses that they will not allow inflation to rise much further, and, in turn, hope they show restraint. This may be a futile wish.

Europe must press ahead with unifying its capital and banking markets to boost the Euro's international role, ECB President Christine Lagarde said yesterday.

In the ECB’s annual report on the Euro’s international role, Lagarde said that means of payment were becoming more varied amid rising geopolitical tensions and innovations such as stablecoins, threatening to leave currencies like the single currency in the lurch.

“There is no room for complacency. Forces of fragmentation are becoming more pronounced,” she said.

“For the Euro to evolve into a truly global international currency, the Eurozone must develop scale and deeper, more liquid capital markets,” she added.

Although the report noted several instances when the Euro seemed to act as a safe-haven currency, rising against the dollar during periods of market stress, including during tariff announcements last year by United States President Donald Trump, it also noted that it was far less popular than the greenback internationally.

The Euro accounted for about 20 per cent of foreign exchange reserves worldwide last year, the report said, compared with 57 per cent for the dollar, putting it in second place.

Yesterday, the single currency fell to a low of 1.1594 and closed at 1.1597. It is entering dangerous territory, and any significant rise in the dollar index following tomorrow's non-farm payroll report could push it into a new range, with a base near its long-term support at 1.1420.

This would be a significant event, given the likelihood of a rate hike in the Eurozone next week, which could be partially offset by currency weakness.

Have a great day!