UK services output slows to five-month low, sending sterling tumbling

UK services industry growth slowed for the second successive month in February, while surging input cost inflation led to prices charged by the sector rising to their highest in almost eight and a half years.

The Markit/CIPS services purchasing managers' index survey for February fell more than expected to a five-month low of 53.3 from 54.5 the month before.

The market had been expecting a smaller decline to 54.1, with any reading above 50 indicating growth.

As a result of the slowdown in services, with the sector accounting for more than three-quarters of GDP, the composite PMI for the UK economy slipped to 53.8 for February from 55.4, again short of the estimated 55.6.

The slowdown in UK business activity growth in February added to evidence that the economy has lost momentum after the impressive expansion seen at the end of last year, Markit said.

Input cost inflation increased to its highest level since August 2008, with Markit finding firms were struggled with rising costs associated with the weak pound, although optimism about the year ahead remained elevated by recent standards.

This led to the largest increase in prices charged by service providers for almost eight-and-a-half years.

Markit also noted indicators from the survey hinted at growth slowing further in March, with growth of new business dipping to a five-month low in February and backlogs of work showed the largest fall for seven months.

Optimism about future activity levels also moderated slightly, albeit remaining at one of the most elevated levels seen over the past year-and-a-half.

While the rate of job creation recovered from January’s slowdown it remained moderate by historical standards, with companies commonly reporting that rising costs continued to curb their appetite to hire new staff.

Market reaction and analysis

Currency markets reacted immediately to the news, with the pound losing around a third of a cent against both the dollar and the euro, while economists said the Bank of England would be even less likely to consider raising interest rates in the near to medium term.

The slowing services number, following on from a modestly softer manufacturing survey and a lacklustre construction one, fuels suspicion that the UK’s economy since last June’s Brexit vote is beginning to crumble and an expected slowdown is now materializing, said Howard Archer at IHS Markit.

"Services have been a key UK growth driver along with consumer spending – and there are clear indications that both are now losing momentum," he said.

"In fact, it is the consumer facing services sectors that have been particularly strong, so this is likely further evidence of consumers becoming more cautious in their spending as their purchasing power is increasingly squeezed by higher inflation. It was reported that weaker consumer spending was a key cause of slower service sector growth in February."

Economist Ben Brettell at Hargreaves Lansdown said 2017 looks set to be a relatively challenging year for the economy, with higher inflation and weaker pay growth likely to squeeze household budgets.

"This means consumer spending could slow in real terms. Today’s figure, along with the equivalent readings for the manufacturing and construction sectors, point to 0.4% GDP growth in the first quarter.

But he said that the overall economic picture remains more positive than many expected after last year’s vote to leave the EU.

"A PMI reading above 50 shows the sector is still expanding, albeit at its slowest pace since September. The survey showed that business confidence remained strong, and sentiment about the rest of the year was largely positive.

"Nevertheless, with uncertainty still rife over how and when the UK will actually leave the EU, and survey data pointing to a modest slowing of activity, the Bank of England looks most unlikely to consider raising interest rates in the near to medium term."

Alex Lydall, head of dealing at Foenix Partners, said the disappointing data represented another black mark on BoE Governor Mark Carney’s list.

"Whilst the headline figures won’t cause panic for the Bank of England, Carney’s warning of the delayed reaction of last year’s Brexit vote could likely be really kicking into gear, ironically just as Article 50 is to be triggered.

"Sterling is having a tough time this week, with any speculation around May’s Brexit plans seemingly bad, despite many market participants believing the ‘worst case-scenario’ is largely priced in. The continuation of inflation woes, coupled with a lagging Service sector and Brexit woes, doesn’t bode well for importers in the short-term."