War fears raise rate cut hopes

War jitters sent Britain's crucial service sector skidding into reverse last month, raising City expectations of a cut in interest rates to prevent a sharp downturn in the economy.

With manufacturing deep in recession, news that the services index from the Chartered Institute of Purchasing and Supply slipped to 49 in March from 50.2 in February, raised fears that the onset of war in Iraq has hindered economic recovery.

CIPS said anxiety about the potential economic impact of the war had helped drag its monthly purchasing managers index of activity in the services sector to below the 50 boom/bust mark for the first time since December 2001, when consumer confidence plunged in the aftermath of the September 11 terrorist attacks on New York and Washington.

"A significant proportion of the survey panel reported that uncertainty had been further heightened by the build-up to, and subsequent start of, war in Iraq," it said, adding that many firms were delaying making investment decisions until the outcome of the conflict became clear.

Orders and optimism fell in March, according to the detail of the CIPS report, and cash-strapped firms are laying off workers at the fastest pace since the survey began in 1996.

John Butler, UK economist at HSBC, said together with a weak reading in the CIPS manufacturing survey earlier this week, yesterday's news suggested GDP growth could slow to an anaemic 0.2% for the first quarter of 2003, down from 0.4% in the final three months of last year.

"The message from the forward-looking indicators is that the lacklustre growth in the UK economy at the end of 2002 has continued into 2003," he said.

With the Bank of England's nine-member monetary policy committee due to set borrowing costs next Thursday, Mr Butler predicted that wobbly business optimism could prompt a cut. "The last time the combined PMI series was this weak was post-September 11 and the monetary policy committee used this knock to confidence as justification to cut rates. Hence this combination clearly increases the chance of a rate cut at either the April or May meeting."

Subdued inflation on the high street could help increase the MPC's room for manoeuvre, according to the British Retail Consortium's monthly shop price index, also published yesterday. The BRC said prices in the shops were just 0.44% higher last month than in March last year, as tough competition eroded retailers' pricing power.

"Retailers are facing ever-tougher conditions on the high street," said the BRC's director general, Bill Moyes. "They are being squeezed between low sales growth and falling prices."