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UK service sector contracts steeply as inflation hits business confidence

ROMFORD, ENGLAND - OCTOBER 27: A woman walks past rundown closed shops in North Street on October 27, 2022 in Romford, England. (Photo by John Keeble/Getty Images)
The fall marks the largest contraction in business activity since the start of 2021 when pandemic lockdowns restricted economic activity. Photo: John Keeble/Getty

The UK service sector witnessed the steepest drop in business activity since January 2021 as political and economic uncertainty hit demand in October.

Output declined sharply, largely due to squeezed household budgets, recession worries, delayed business investing because of rate hike fears and supply chain woes due to the legacy of pandemic lockdowns and Russia's invasion of Ukraine.

The S&P Global UK Services Purchasing Managers' Index (PMI) fell to 48.8 in October, slipping below the 50.0 growth threshold level, which is where the index sat in September.

However, the PMI data was higher than a forecasted drop to 47.2 points.

The fall marks the largest contraction in business activity since the start of 2021 when pandemic lockdowns restricted economic activity.

Read more: Inflation: Milk, tea bags and sugar prices soar as food bills hit record highs

The UK's service sector reported high rates of input cost inflation amid higher staff wages and energy bills, with these stresses coming in addition to pressure from a depreciating pound (GBPUSD=X).

In the UK, the services sector is larger than the manufacturing sector and thus accounts for the largest share of the country’s economic output, so economic policymakers watch these results with a particular focus.

Tim Moore, economics director at S&P Global Market Intelligence, said: "UK service providers reported the steepest drop in business activity for 21 months in October as household spending cutbacks and shrinking business investment combined to dent new order volumes.

"A number of firms noted that political uncertainty and rising borrowing costs since the mini-budget had led to greater risk aversion among clients and a wait-and-see approach to new projects.

"There were also many reports that higher energy bills had led to reduced spending on non-essential services."

S&P Global said: "Although only modest, the latest reading signalled the fastest rate of decline since January 2021. Manufacturing production fell at a much faster pace than service sector activity,"

The uncertainty caused by price inflation sent business confidence sharply down compared to September.

Private sector growth projections were at their weakest level since April of 2020.

Moore said: "Stubbornly high inflation, increased borrowing costs and worries about the UK economic outlook all contributed to weaker business optimism in October. Aside from the slump at the start of the pandemic, the degree of confidence across the service economy is now the lowest since December 2008."

S&P Global added: "Slower rates of input price inflation were seen in both the manufacturing and service sectors in October, despite severe pressure on business expenses from higher energy bills and staff wages."

Read more: Interest rates: What the Bank of England's biggest hike in 33 years means for you

The PMI data reinforced other signals that the UK economy is decelerating month on month, a concern for the Bank of England which look set to raise interest rates sharply on Thursday.

The combination of stagnating economic growth and inflation could lead to stagflation, a combination of factors that economic policymakers find particularly difficult to handle, as attempting to correct one can exacerbate the other.

Watch: What is a recession and how do we spot one?