Service sector stalling

SERVICE companies, the backbone of the economy, set alarm bells ringing yesterday as they reported the worst monthly downturn since September 2001 and said they do not see a swift resolution of the situation in the Gulf as a panacea for poor growth.

In a shock report that shook market confidence in the health of the economy, the Chartered Institute of Purchasing and Supply (CIPS) said new business in the service sector in February fell for the first time in more than a year. The closely-watched CIPS Purchasing Managers’ Index, which gauges the general health of the services industry, plunged to 50.2 from 52.3 in January - the biggest monthly fall since the 11 September tragedies in New York (see Chart of the Day).

The performance was substantially worse than the prediction by most City economists of a modest slide to around 52, and leaves the bulk of the UK economy just one bad month away from a PMI reading below 50 - the point at which output starts shrinking.

At a time when manufacturing industry is ploughing headlong into recession, the gloomy news was a blow to stock market sentiment. The FTSE 100 sank 62 points to close down 1.7 per cent at 3563.5.

Service firms said February marked another month of discounting and squeezed margins - a bad omen for investors looking for a renaissance in corporate profitability to make equities more attractive.

The financial intermediation industry, a stalwart of growth in Scotland, reported one of the sharpest falls in new business. Hotels and restaurants also endured a miserable month.

Many firms said they see poor demand, not the uncertainty of hostilities in the Gulf, as the biggest barrier to growth in the months ahead.

Economist and author of the CIPS report Luke Thompson said: "There is a theory that if the war in Iraq is concluded quickly the UK economy will recover quite strongly.

"But what we are hearing from companies about the weakness they face in underlying demand shows it is possible we would see only a minor improvement in the economy."

Given the importance of the service industry to the domestic economy, the findings could influence the latest interest rate decision due today from the Bank of England monetary policy committee.

Consensus opinion in the City last night said the MPC, which often discusses the CIPS report in its meetings, is likely to hold the cost of borrowing at 3.75 per cent - but the verdict is expected to be a close call and the committee could choose to cut rates by a quarter point.

Any thoughts the European Central Bank, meanwhile, will freeze interest rates in the eurozone were washed away yesterday by a report on the service sector in Europe. Reuters said its PMI barometer for the service sector on the Continent, the equivalent of the CIPS index, crashed deep into the red in February. Activity slipped for the first time in five months to 48.9.

The ECB is widely-expected to chop the cost of borrowing today by up to 50 basis points in a bid to stoke life into the moribund eurozone economies.

The service sector in the US also slowed in February. The Institute for Supply Management yesterday said the PMI for services across the Atlantic dipped to 53.9, from a robust 54.5 in January.