By Claire West

UK service sector activity increased at a disappointing pace in February following January’s weather-related bounce, reveals the Markit/CIPS UK Services PMI. Forward-looking indicators from the survey were positive, signalled by new business rising at a solid rate and confidence strengthening to a nine-month peak. However, with spare capacity still evident, another marginal cut in employment was signaled.

February’s seasonally adjusted Markit/CIPS Business Activity Index read 52.6, down from January’s eight-month high of 54.5, and failing to reach the expected level of 53.7. This was also disappointing in comparison to the strong February results for manufacturing (61.5) and construction, which reached an 8 month high of 56.5. Latest data for services pointed to a second consecutive monthly rise in activity following December’s snow-related contraction, with the rate of growth at a level comparable to the average for the second half of 2010.

David Noble, Chief Executive Officer at the Chartered Institute of Purchasing & Supply said: “the latest PMI data is certainly shy of what we might have hoped for. January’s bounce back petered out slightly, back to below average growth performance compared to 2010. The sector remains on the sidelines as reliance on manufacturing and construction for GDP growth intensifies. Inflation, a threat which is impacting on all areas of the economy, has been one of the biggest burdens for this all-important sector. Input prices continue to increase at a historically steep pace, affecting those in consumer facing and transport industries the most.”

Jeremy Cook, chief economist at foreign exchange brokers World First agreed: “While we’ve seen increases for both the construction and manufacturing sectors in the past few months the services sector, which makes up 70% of the UK economy, has dipped in February.

“This is not something that can be blamed on the weather, however, as it is a simple lack of consumer confidence that is causing the ‘man on the street’ to refrain from spending money. The new fridge and TV can wait, while prices increase and the jobs market still looks perilous."

Job losses were again recorded in February, extending the current sequence of decline to five successive months. Service providers chose to not replace leavers or to implement redundancies as part of efforts to keep costs under control although, overall, the rate of contraction was only marginal. Latest data also provided evidence of spare capacity, with work outstanding declining at a solid pace.

Price indices from the survey were little changed in February, in both cases down only marginally from peaks seen at the start of 2011.

Input price inflation remained historically steep, with fuel and utilities widely reported to have increased. There was also evidence of higher food costs and reports that the rise in VAT continued to be felt. Hotels, Catering & Restaurants and Transport, Storage & Communications signalled the sharpest rates of cost inflation.

VAT also played a role in pushing output prices higher in February. There were also reports of efforts to protect margins following another round of input price increases. Output charges have now risen in each of the past five months.

Cook observed: “It seems that the VAT increase was lost in price discounting during January, but consumers may have also used this as a reason to keep their wallets in the pockets. This will come as a blow to the coalition and also will reduce the likelihood of an interest rate increase from the Bank of England in the next few months.”

Nevertheless, it was not entirely bad news, as solid growth of activity and new business bolstered expectations in the latest survey period, with confidence rising to a nine-month peak. February marked the fourth successive month that sentiment has improved, with around 54% of the survey panel indicating positive expectations. A number are forecasting the continuation of economic recovery which should have a positive impact on planned new product launches and marketing campaigns.

Altogether, the results point neither to recovery, nor to further decline. Putting all the data together, Paul Smith, Senior Economist at survey compilers Markit , predicted: “Even with strength in manufacturing and the upside surprise to February construction data, the economy looks likely to deliver a rate of expansion that only offsets the decline in final quarter of 2010 to leave the underlying trend in GDP ‘flattish’.”