LONDON Britain's services sector shrank for the first time in two years in December, a survey showed on Friday, suggesting the broader economy contracted in late 2012 and could be headed for its third recession since the financial crisis.
The Markit/CIPS services Purchasing Managers' Index (PMI) dropped to 48.9 in December - its lowest reading since April 2009 - from 50.2 in November, confounding many economists' forecasts for a small rise.
A reading below 50 indicates that activity shrank.
Markit said the PMI data pointed to a 0.2 percent quarterly fall in Britain's economic output in the final three months of 2012, and raised the risk of a further drop in the first three months of 2013, which would put Britain in its third recession in four years.
"The PMIs point to an economy that is contracting modestly," said Rob Wood, an economist at Berenberg Bank.
"A big thing that is not often picked up ... is that future business expectations remain very weak," he added. "It would not be a surprise to see recorded output fall in either, or both, of the fourth quarter of 2012 or the first quarter of 2013."
The PMI data helped push sterling to its lowest in more than three weeks against a broadly firmer dollar.
Britain's economy has struggled to recover from the 2008-09 financial crisis, which saw it shrink by 6.3 percent, and output still remains 3 percent below its 2008 peak - a far weaker state than in most other major economies.
The country faces headwinds from weak demand in the euro zone, its major trading partner, as well as the UK government's austerity drive and a financial sector that is much less willing to lend than before the crisis.
There have been partial signs that bank lending may be starting to improve, with Bank of England data on Friday showing the highest number of mortgage approvals since January, though levels are still far below those seen before the crisis.
In August the Bank opened a Funding for Lending Scheme (FLS) which offers banks cheap credit if they keep up or increase lending, and Wood - a former Bank economist - said this should help the economy later in 2013.
"As we head into the second half of the year, we still expect the UK to return to gradual growth, in part as credit conditions ease with the FLS," he said. "Today's (mortgage approval) figures are one positive indication of this. Fragile but stable is how I would describe the UK economy."
Economists polled by Reuters early in December expected Britain's economy to grow by 1.1 percent in 2013 after contracting 0.1 percent in 2012.
In the short term Friday's data indicated that Britain's economy had contracted again, just three months after it left its last recession.
That would be a blow to Chancellor George Osborne, as many Britons blame his aggressive programme of spending cuts and tax rises for sluggish growth since the 2010 election when a coalition of Conservatives and Liberal Dems came to power.
It may also raise questions about whether the Bank will restart its programme of bond purchases, which it suspended in November - though most economists think above-target inflation and signs the FLS may be effective will dissuade policymakers.
"Quantitative easing will remain on the back burner for the time being," said Peter Dixon, an economist at Commerzbank.
December was the first time the services PMI has fallen below the 50 mark that separates growth from contraction since December 2010, when unusually heavy snow disrupted business, though official services data have shown falls since then.
Although December 2012 was very wet, weather disruption was less widespread than two years ago, and Markit said underlying economic weakness made a rapid rebound in services unlikely.
The services sector new business index dropped to 49.4 from 49.6, hitting its lowest level since December 2010, while employment also fell and the rate of price increases slowed.
"Market conditions were subdued, with client budgets being tightened towards the end of the year. There was evidence that clients were holding back from committing expenditure, preferring instead to focus on cost control at a time of ongoing economic uncertainty," Markit said.
The services survey covers firms in the transport and communication, financial and business services, computing, hotels and restaurants sectors, but does not include retailers or public sector services.
(Additional reporting by Estelle Shirbon and Dasha Afanasieva; Editing by Susan Fenton)