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Services sector: Bank of England must act while Osborne won’t

The appalling PMI data will put pressure on the chancellor but political constraints mean a U-turn is unlikely. At the moment it’s up to Threadneedle Street to help avoid the double dip

George Osborne was cock-a-hoop when the monthly health check of Britain’s services sector was published a month ago. The July findings from purchasing managers were surprisingly upbeat and within minutes the chancellor’s aides were spreading the news that the government’s tough love remedy for the economy was working.

Needless to say, there were no instant text messages this month. The August services PMI, published on Monday, was an absolute shocker, with the index of activity dropping from 55.4 to 51.1 – a sharper monthly fall than seen during the worst of the financial crisis in late 2008.

Osborne may perhaps take some comfort from the fact that the PMI has not sunk below 50, the cut-off point between expansion and contraction, at least not yet. It is also possible that the riots in early August had a modest impact on consumer spending.

But this is clutching at straws. Firms operating in the services sector reported less business coming in and cut jobs at a faster rate than they did the previous month. Optimism about future prospects was at its lowest in more than a year.

As Samuel Tombs, UK analyst at Capital Economics, notes, a services sector PMI at this level is traditionally associated with quarterly contraction of 0.2%. Services account for 75% of national output and the PMIs for manufacturing and construction released late last week were also flashing recessionary warning signs.

What does that add up to? Simple. It adds up to an economy smack on course for a double-dip recession. Consumer confidence is at rock-bottom levels. Businesses are not investing. Britain’s main export markets are slowing fast. All this at a time when government spending is being squeezed in an attempt to bring down Britain’s budget deficit.

A year ago Osborne boasted that, as a result of his austerity programme, the UK was out of the danger zone. Since then the UK economy has expanded by 0.2% in nine months, with the prospect of a long, tough winter ahead. Ed Balls, the shadow chancellor, has repeatedly warned that Britain, after the longest and deepest recession in living memory, was not strong enough to cope with big tax increases and spending cuts. All the evidence suggests that when it came to the big calls on the economy, Balls was right and Osborne was wrong.

The Bank of England will have the chance to respond to the recent run of poor economic data when its monetary policy committee meets later this week. The Bank rate is clearly on hold at 0.5% for the rest of 2011 and probably the whole of 2012 as well, and the main interest will be on whether Threadneedle Street announces a fresh dollop of quantitative easing, the creation of electronic money through the purchase of bonds. That seems unlikely this month, although it is now looking a real possibility later in the autumn.

The other big question is whether Osborne does a U-turn on fiscal policy. Some slippage in the deficit reduction programme is inevitable given that slower growth means lower tax receipts and higher bills for welfare. The chancellor can allow these so-called automatic stabilisers to come into play while sticking to his aim of eliminating Britain’s structural budget deficit over the course of this parliament. He is, however, likely to come under considerable pressure to go further than that, and Balls will certainly be making the case for discretionary tax cuts and a slower pace of spending cuts to underpin activity. That, though, would be a momentous political as well as economic decision for the chancellor; one that would severely (and perhaps irrevocably) damage his credibility. In the short term, therefore, the onus is on the Bank to haul the economy out of the recessionary quicksand into which it is rapidly sinking. © Guardian News & Media Limited 2011 | Use of this content is subject to our Terms & Conditions | More Feeds