Fears for recovery as Arctic weather and cuts halt service sector growth

• Hotels and restaurants are bearing most of the pain as the services sector contracts for the first time in 20 months, heightening fears for recovery. Picture: Getty

Economists said GDP was likely to have expanded by just 0.4 per cent in the last three months of 2010, a little over half the growth rate recorded in the third quarter of the year. During the second quarter, the UK economy grew by a heady 1.1 per cent.

The downgrade in growth estimates follows the publication of the latest services purchasing managers' index (PMI) from the Chartered Institute of Purchasing and Supply (Cips)/Markit.

Its main activity barometer slumped to 49.7 in December when many analysts had expected it to hover around November's reading of 53. A figure below 50 indicates contraction.

Arctic weather conditions were blamed for the first fall in new business since mid-2009, with hotels, restaurants, caterers and personal services bearing the brunt of the disruption.

However, there were also signs that central government cuts stunted growth with the public sector a source of demand weakness in the services sector, which accounts for more than two-thirds of the UK economy.

PMI reports earlier this week showed the construction sector had also slipped into decline in December, leaving manufacturing as the only part of the economy in growth.

Howard Archer, chief UK economist at forecasting group IHS Global Insight, described news of the contraction in services as "a bit of a shocker".

He said: "It is evident that December's severe weather had a significant adverse impact on the sector.

Nevertheless, the survey fuels concern that services activity is already being pressurised appreciably by the fiscal squeeze."

Sterling weakened against the dollar following the survey although the reaction on the government bond market was muted.

Some economists said the figures did not mean service sector contraction was inevitable this year, as activity bounced back strongly from similar weather disruption in early 2010.

Stephen Lewis, strategist at Monument Securities, said: "I'm a little surprised by the market reaction as I would have thought that it was fairly clear that the weather was going to have a substantial negative impact.

"However, looming public spending cuts will have more of an impact on services than manufacturing so there probably is some underlying weakness creeping in there."The report revealed that the number of people employed in the sector declined for the third month in a row and at a faster rate than in November.

Prices increased at their fastest pace since September 2008 and businesses were not able to pass all of the rise on to customers because of weak demand.

David Noble, chief executive at Cips, said: "Fiscal tightening will continue to be a big theme in the coming year, particularly for companies reliant on the domestic market. We must hope that there will be spillover from the booming manufacturing sector which might ease some of our worries."

Archer said the survey's findings reinforced his belief that the Bank of England would keep interest rates on hold next week. Its monetary policy committee is likely to wait for additional early reaction to this week's VAT hike.