Recession nears as UK services shrink - The Guardian

Britain's economy looks on course for a second recession in three years after official figures for October showed the dominant service sector contracted at its fastest pace since the spring.

A fall of 0.7% in services output, which accounts for about three-quarters of the economy, was larger than many analysts expected and showed the economy had slipped into a lower gear recently.

Economists said the sector could contract further next year as the government cuts public-sector services.

The service sector was the main driver of growth in the third quarter, when the economy expanded by 0.6% on the quarter. If services stagnate or contract over the last quarter of the year, a recession is almost certain. The Office for National Statistics (ONS) said the big drags on services output were telecommunications, computer programming, and financial services excluding insurance and pension funds.

In the eurozone, Italy's government cleared the final legislative hurdle in its efforts to secure €30bn (£25bn) of cuts and tax rises after the upper house passed the package of austerity measures into law.

But the move failed to persuade investors that Rome's financial difficulties were in the past, and traders increased the cost of Italy's borrowing rates.

Yields on the 10-year Italian bond rose eight basis points to breach the all-important 7% mark that investors believe means a country is in effect locked out of debt markets.

Spain, which has signalled that its banks need a further injection of funds to shore up their fragile finances, also saw its 10-year bond yield, which reflects the real cost of borrowing for governments, increase two basis points to 5.41%.

By contrast German and UK bond yields fell, with UK yields tumbling to below 2%.

The UK is considered a safe haven largely because it has its own exchange rate and control over its money supply through the Bank of England.

The pound has lost about a quarter of its value since the banking crisis, easing the debt burden by the same amount.

The Bank of England has spent £275bn through its policy of quantitative easing (QE) to support bank lending and prevent the economy from contracting.

The European Central Bank (ECB) has shied away from QE, relying instead on direct loans. Outgoing ECB board member Lorenzo Bini Smaghi said his colleagues could copy the UK and the US Federal Reserve, and use their power to create new money if a deteriorating economy threatens the eurozone with falling prices.

However, Smaghi, who is leaving office next week, aligned himself with other ECB members who have resisted going beyond their mandate of keeping prices stable.

Urgent measures to reduce Spain's bloated deficits will be approved next week, said the deputy prime minister, Soraya Sáenz de Santamaría, after the new government's first cabinet meeting on Friday. Employers and unions have until 7 January to come up with a labour reform agreement to help get the country's near five million jobless back to work.

The deterioration in the UK service sector will increase pressure on the chancellor, George Osborne, to drop his austerity programme in favour of a slower schedule of cuts.

The Bank of England governor, Mervyn King, is known to be concerned that the UK economy will falter over the coming months. He is worried that major industries are being starved of lending and are losing confidence in the ability of banks to support them through difficult times.

Earlier this month, the Markit/CIPS purchasing managers' index (PMI) showed the service sector picked up slightly in November, defying forecasts that it would continue to slide.

But Markit's chief economist, Chris Williamson, pointed out that government spending, which provided the main boost to services growth in October, was likely to weaken as budget cuts hit.

"Worryingly, the government provided the main boost to services growth in October, with output up 2.3% on a year ago and growing at more than double the 1.1% annual expansion seen for the sector as a whole," he said. "Government spend should weaken in coming months as budget cuts hit, taking this prop away from the economy.

"The service sector therefore appears to have shifted down a gear since the summer, which is in line with the PMI survey for the sector. The more timely PMI also suggests that growth remained lacklustre at best in November," he said.