Weak service sector raises fears for faltering economy

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The prospects of a "double dip" recession strengthened yesterday with the publication of a survey of business sentiment and activity in the largest sector of the economy, services.

A reliable leading indicator, the Chartered Institute of Purchasing and Supply's July poll of managers at the sharp end of the service sector showed a more dramatic fall than expected last month – the fourth decline in five months. It suggests that the 1.1 per cent quarterly growth rate over the April to June period of this year, around double the pace of recovery anticipated by most economists, may have been a false dawn, and that this rate of revival is unlikely to be sustained later this year.

Better news arrived from the Halifax, showing average house prices up 0.6 per cent on the month, but this signal – among a welter of negative data about the property market – failed to lift the gloomy mood among City economists.

The Cips survey's reading for the service sector slid from 54.4 to 53.1, taking it to its lowest level since June 2009. Any reading above 50 is suggestive of an expansion in output in around six to nine months' time, so the slippage is suggestive of growth, but falteringly so, in the medium term.

As with the disappointing results from Cips surveys in construction and manufacturing earlier in the week, the services sector readings have been driven lower in recent months by a wave of renewed pessimism about future prospects for the economy. These appear to have been spurred by speculation about "savage" public spending cuts leading up to the emergency Budget on 22 June, and the announcements the Chancellor made, especially the rise in VAT to 20 per cent next January.

Combining the three Cips surveys indicates third-quarter growth of about 0.3 per cent to 0.5 per cent of GDP, a marked slowdown which will delay the return to economic normality further.

The news came as the Bank of England's Monetary Policy Committee gathered to decide the next move in interest rates and quantitative easing, which will be announced at noon today. Few expect any movement, as the balance of risks is unusually finely balanced; so much so that one of the external members of the MPC, Adam Posen, has commented that the chances of inflation overshooting or undershooting the 2 per cent official target wildly are greater than the target being actually being met.

Opinion in the MPC is divided between those who believe that the weight of unused capacity will bear down on prices, against those who think that the danger of public expectations of higher inflation and a pass-through of higher import prices from the devalued pound will outweigh that effect.

Most MPC members concede the validity of both sets of arguments, and the balance of opinion seems weighted towards a "no change" policy for many months. Most City economists believe rates will stay at 0.5 per cent until the middle of next year. Even a rise to 0.75 per cent would leave rates historically low.

As things stand the Governor of the Bank, Mervyn King, has said the inflation target is likely to be overshot for "much" of next year, while the Bank's chief economist, Spencer Dale, has suggested that the outlook for growth has deteriorated since the Bank's last Inflation Report. The Bank's next report is due to be published next Wednesday.