Service sector slowdown rings recession alarm bells

By Matt Falloon and Christina Fincher

LONDON (Reuters) - The dominant services sector shrank in June at its sharpest rate since the aftermath of the 9/11 attacks on the United States, in a sign the economic slowdown is gaining traction and raising fears of a recession.

Researchers who compile the Chartered Institute of Purchasing and Supply/Markit survey now think the economy is flirting with a recession, with the composite reading of the services, manufacturing and construction sectors diving to a series low.

That view was supported by a separate survey released by the Bank of England on Thursday that showed lenders expect to further reduce mortgage lending to households and tighten credit criteria in coming months.

"Remember that the manufacturing and construction surveys released earlier this week weakened sharply too," said Vicky Redwood, UK economist at Capital Economics.

"A weighted average of the three surveys points to gross domestic product more or less stagnating by the end of the second quarter -- a technical recession may be closer than we thought."

Economic contraction in two successive quarters constitutes a technical recession.

However, services providers -- ranging from banks to restaurants -- are still raising their prices to partly offset record cost inflation, and that is likely to reinforce the view that the Bank is no position to cut interest rates yet to help boost growth.

"We suspect that with inflation likely to peak at around 4.5 percent late this year and the BoE concerned about potential second round price effects through a price-wage spiral, that there is little scope for a rate change before year-end, up or down," said James Knightley of ING Financial Markets.