UK economy slows after surprise contraction within services sector

The UK’s private sector recorded its worst month since the start of 2021 in August after a surprise downturn hit the services sector, increasing concerns about the risk of recession.

A closely watched survey of UK business output showed a contraction in August, defying economists’ expectation of modest growth after six consecutive months of expansion. Manufacturing and services companies reported weaker output, falling new orders and a rising wage bill.

The monthly composite Purchasing Managers’ Index fell from 50.8 in July to 47.9 this month, the worst performance since January 2021 and below the 50 threshold that separates growth from contraction. July was the first time that the composite measure has dropped under 50 since the start of the year.

The UK economy has posted modest growth this year, helped along by the economy’s dominant services sector, which had continued to power ahead despite rising interest rates and inflation. But S&P Global, which helps compile the survey, said service industries reported pressures from the cost of living squeeze and recorded the weakest output in 31 months.

Manufacturers also continued to struggle after a year of woes caused by high inflation, weak global demand from slowing economies in China and Europe, and a slowdown in the UK that has also hit appetite for manufactured goods.

Chris Williamson, chief business economist at S&P Global, said the PMI figures pointed to an overall contraction in growth of 0.2 per cent in the third quarter of the year, following a 0.2 per cent expansion in the previous three-month period.

“A renewed contraction of the economy already looks inevitable, as an increasingly severe manufacturing downturn is accompanied by a further faltering of the service sector’s spring revival,” Williamson said.

“Companies are reporting reduced orders for goods and services as demand is increasingly hit by the cost of living crisis, higher interest rates, export losses and concerns about the economic outlook.”

He added that the early PMI survey suggested that inflation should moderate further in the months ahead, “but also indicates that the fight against inflation is carrying a heavy cost in terms of heightened recession risks”.

The poor figures will raise the prospect of fewer interest rate rises from the Bank of England this year as the economy and inflation slow down.

Financial markets have priced in at least three more quarter-point increases from the Bank this year, to take the base rate close to 6.25 per cent. But in encouraging news for the private sector and the Bank, measures of input inflation are falling dramatically with the declining cost of energy and improved global supply chains.

Average prices charged by UK businesses rose by the weakest rate since February 2021 this month and have now been slowing for four months in a row. This should eventually trickle down into overall measures of consumer price inflation, which have dropped from a peak of 11.1 per cent last autumn to 6.8 per cent in July.

Service sector businesses, however, reported higher wage bills, as workers are securing better pay deals to compensate for the broad increase in prices across the economy for the last year. The Bank is keeping a close watch on wage developments in the service sector as a proxy for domestic inflation.