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Economy set to shrink as UK service sector suffers 'worst month in decade'

Oscar Williams-Grut
Senior City Correspondent, Yahoo Finance UK
The Shard is seen as workers use umbrellas to shelter themselves from the rain while crossing London Bridge in London. Photo: Eddie Keogh/Reuters

New figures suggest the UK economy may have shrunk in the second quarter, the first quarterly contraction in three years.

Data provider IHS Markit published its closely-watched service sector PMI on Wednesday, which is a survey measuring business activity and future intentions.

The data pointed to a significant slowdown in the engine room of economic growth. Service sector PMI for June came in at 50.2, versus a forecast of 51. (Anything above 50 signals growth, anything below means contraction.)

IHS Markit said the figure showed “business activity was close to stagnation in June, which contrasted with the modest recovery seen during the previous month.”

The findings add to a bleak picture painted by data from other sectors. Earlier this week, an IHS Market survey of the construction sector found it suffered its worst month since the financial crisis in June. IHS Markit’s data for the manufacturing sector also hit a six-year low.

‘The economy has slipped into contraction’

“The near-stagnation of the services sector in June is one of the worst performances seen over the past decade and comes on the heels of steep declines in both manufacturing and construction,” Chris Williamson, IHS’s chief business economist, said in a statement.

“Collectively, the PMI surveys indicate that the economy has slipped into contraction for the first time since July 2016, suffering the second-steepest fall in output since the global financial crisis in April 2009.”

Williamson said IHS Markit’s data suggests the UK economy contracted by 0.1% in the second quarter.

READ MORE: Pound slides as UK manufacturing hits six-year low

Samuel Tombs, the chief UK economist at Pantheon Macroeconomics, said the growth forecast was “plausible, given the drag from the unwind of Q1’s stockpiling boost,” but noted PMI data has recently been too pessimistic and underestimated GDP growth.

James Smith, an economist at ING, warned that “the fact that new orders have ground to a halt in the service sector suggests that underlying economic momentum is unlikely to increase imminently.”

Shortly after the IHS Markit data was published, the pound was down by 0.1% against the euro (GBPEUR=X) and down by 0.1% against the dollar (GBPUSD=X). Sterling was under pressure against both currencies prior to the announcement.

‘Ongoing Brexit uncertainty’

The slowdown in the service sector was blamed on “sluggish domestic economic conditions and greater risk aversion among clients in response to ongoing Brexit uncertainty.”

“The latest downturn has followed a gradual deterioration in demand over the past year as Brexit-related uncertainty has increasingly exacerbated the impact of a broader global economic slowdown,” Williamson said.

READ MORE: Pound falls on UK construction's worst month since crisis as Brexit bites

The service sector, which covers everything from banking to waiting tables, accounts for around 80% of economic growth in the UK.

One of the few bright spots from IHS Markit’s survey was an increase in service sector hiring. Employee numbers grew at their fastest rate since August 2017.

IHS Markit said some companies were “anticipating a rebound in demand following greater clarity about the path to Brexit.” However, other survey respondents expected continued tough conditions to continue due to “domestic political uncertainty and subdued global economic conditions.”

Pressure on the Bank of England

Williamson said the data would “put further pressure on the Bank of England to add stimulus.”

“For policymakers to not loosen policy with the all sector PMI at its current level would be unprecedented in the survey’s two-decade history,” he said.

The Bank of England has said publicly it wants to raise interest rates but has been hamstrung by weak economic growth. Investors now judge a rate cut to be more likely than a rise.

READ MORE: Bank of England holds interest rate at 0.75% as 'downside risks' increase

The Bank of England last month cut its growth forecast for the UK to zero in the second quarter of 2019. The MPC said UK economic growth appears to have “weakened slightly in the first half of the year” and said “downside risks to growth have increased.”

Governor Mark Carney also struck a downbeat tone in a speech on Tuesday, warning that US-China trade tensions could “shipwreck the global economy.”

ING’s Smith said the Bank of England was “unlikely to hike interest rates this year” due to ongoing Brexit uncertainty and “the potential for an escalation in global trade tensions.”

However, Pantheon Macroeconomics’ Tombs said he doubted there was “a greater than 50% chance of the MPC cutting Bank Rate before Governor Carney steps down at the end of January.”

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Oscar Williams-Grut covers banking, fintech, and finance for Yahoo Finance UK. Follow him on Twitter at @OscarWGrut.

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