Service sector has its bright spots

News Analysis: There is no evidence yet of the across-the-board decline that has hit manufacturing

THE OUTLOOK for the UK economy seems to get darker by the day. Last week, the Bank of England cut interest rates for the third time in as many months. This week, a raft of official data releases - inflation, unemployment, retail sales - will prompt another round of economic pessimism.

Amid the gloom, and there is plenty of it, it is easy to forget that companies in the UK service sector are still flourishing. For many, 1998 has been as good a year as 1997. If the economy is to escape recession next year, these companies must keep on growing. What are the chances?

Until recently, the UK service sector looked unassailable. According to the latest official estimates, business services - that is, professional services such as management consultancy - grew by an annualised rate of around 7 per cent in the first six months of the year.

The UK telecoms industry grew by more than 10 per cent. Services prices have continued to increase, reflecting buoyant demand as well as a shortage of skilled labour. The latest inflation data put services inflation at 3.4 per cent, more than three-times the rate of goods inflation.

Lately though, the outlook has started to look a little less rosy. Retailers were the first to feel the pinch of slowing domestic demand. Recent official data, as well as the more timely surveys of retail sales, have been dire.

The country's leading retailers, including the stalwart Marks & Spencer, began warning of a "bloodbath" on the high street. The autumn sales are still on, even though there are only a few weeks until Christmas.

The new price index published last week by the British Retail Consortium showed that prices on the high street last month were 1 per cent lower than at the same time last year.

Retailing aside, there are signs of weakness in other service companies that directly serve UK consumers. Last week, Scottish & Newcastle became the latest in a string of brewers to express caution about the near-term outlook.

"There is still reason to be concerned about consumer confidence," said Sir Alistair Grant, the group's chairman.

Times are getting tougher for hotels and caterers too, where official figures indicate that growth, is, at best, stagnating.

But not all the so-called "consumer service" companies are suffering, suggesting that there may still be life in the UK consumer yet. Demand for certain "big ticket" items, foreign holidays for example, is still holding up. "We're not seeing any evidence of a significant downturn in consumer demand," said Bill Nightingale, head of investor relations at the holiday company Airtours. "If anything, we're slightly ahead of where we thought we'd be."

Forward-looking surveys, though, suggest Airtours' experience is the exception not the rule. A recent Confederation of British Industry/Deloitte & Touche survey found that confidence had fallen sharply among "consumer service" companies such as restaurants and bars.

"Consumer services firms expect the volume of business to be lower and to see a sharp cut in the value of future business," said Martin Scicluna, chairman of Deloitte & Touche.

Financial services are also showing signs of faltering. Investment banks have been laying staff off since the summer's financial crisis. However, the weaknesses seem, to date at least, less pronounced than for "consumer service" companies. Most major retail banks insist loan quality is holding up, and consumer lending continues to grow sharply. The latest CBI survey found that although there had been sharp falls in confidence among financial services companies, most were still reporting healthy business volumes.

There is still one bright spot in the services sector - professional and business services such accountancy, management consultancy and IT. Many of these companies are enjoying record levels of profit. This is in part because issues such as the launch of the euro, the year 2000 and the breakneck pace of change in many industries keeps them busy despite weakening domestic demand.

And it is partly because the bulk of work for accountants and consultants and the like comes from other companies, not individual consumers. It takes time for slowing consumer demand to feed through into lower demand for professional services.

Andrew Given, group finance director of Logica, the IT consultancy, said: "We are not seeing any evidence of a slowdown in the market sectors in which we tend to operate - finance, telecommunications and utilities. Our business is growing and we expect it to continue to grow. We are still recruiting strongly, for example."

Simon Gaysford, chief executive of London Economics, a privately-owned consultancy, paints a similar picture. "We're trading strongly and our pipeline is looking strong," he said. "We're keeping a constant eye on things but there's no sign of any deterioration."

The accountancy firm KPMG is also upbeat, although Alan Reid, head of finance, has noticed a slowing in business in northern England. "We've seen some indications of weakness in our northern business area, that is, from Leeds to Manchester. There are also some indications in the Midlands. But we've seen no sign of a downturn in London," he said.

So although growth in services is undoubtedly slowing, there is as yet no evidence of the across-the-board decline that has hit the manufacturers. A combination of structural factors and cuts in UK interest rates should stop the economic slowdown spreading to all parts of the sector, although it seems inevitable that retailers and other companies directly exposed to UK consumers are in for a shaky start to 1999.

With a bit of luck, the economic slowdown that most forecasters have pencilled in for next year should not turn into anything nastier.