Service sector troubles set to keep interest rates on ice

AN INTEREST rate freeze this week was virtually sealed yesterday as a key report showed Britain’s all-important service sector was failing to drag the economy out of the mire.

The revelation that employment levels were static last month, new business growth had slowed while confidence among service providers had slipped to its lowest point since October makes it a near-certainty that the Bank of England will tomorrow leave rates pegged at 0.5 per cent.

Accounting for almost three-quarters of GDP output and spanning everything from bars and restaurants to transport and communication, the service sector is crucial to the well-being of the economy.

Yesterday’s monthly Markit/Cips purchasing managers’ survey provided some initial grounds for optimism, with the headline activity index nudging up to 53.9 from a three-month low of 53.8 in May. Any reading above 50 denotes growth.

However, the figure remains below its long-term average and economists said much of the report’s findings pointed to lacklustre expansion.

The coalition government is also banking on manufacturing – roughly about 15 per cent of GDP – to help buoy the economy as it embarks on swingeing cuts within the public sector.

But a similar purchasing managers snapshot for the manufacturing sector, published last week, revealed the slowest pace of growth for nearly two years in June.

Rob Harbron, economist at the Centre for Economics and Business Research, said: “The latest below-trend figures from each sector provide support for Bank of England monetary policy committee members in favour of keeping rates on hold this week.

“Fragile prospects for the services sector are expected to continue through 2011 as UK consumers see their incomes squeezed between the pressures of soaring inflation and weak income growth.”

Figures released today by the British Retail Consortium (BRC) are certain to add to the headache facing central bank policymakers, who are trying to keep a lid on inflation as the economy struggles to gain traction.

According to the trade body, consumers saw overall shop price inflation hit 2.9 per cent in June, up sharply from the 2.3 per cent recorded in May. Food inflation accelerated to 5.7 per cent.

The official measure of consumer inflation is currently running at 4.5 per cent, more than double the Bank of England’s target, but rate-setters are reluctant to raise borrowing costs for fear of snuffing out the recovery.

Howard Archer, chief UK economist at forecasting group IHS Global Insight, said: “The services survey is unlikely to markedly change the growing view that the Bank of England will keep interest rates down at 0.5 per cent until well into 2012. It is also unlikely to stop growing speculation that it could revive quantitative easing, although we remain dubious that this will happen unless the economy really goes belly up over the coming months given current significant inflation risks and concerns.”

Markit estimated that the UK economy was likely to have expanded by 0.3 per cent at best over the second quarter, having grown by 0.5 per cent in the first, according to official data.

Companies’ input prices increased at their slowest rate since December, yesterday’s survey showed, but the rising cost of food and utility prices meant inflationary pressures remained high.

David Noble, chief executive at Cips, said: “The sector has returned to normality following the recent bank holiday shake up.”