UK private sector shrinks payrolls as weak demand and tax rises spur recession fears

UK private sector hiring has fallen at its fastest rate since the global financial crisis (excluding pandemic disruptions), compounding fears that the economy may be edging closer to recession.

Fresh data indicates that rising employment costs, triggered in part by Chancellor Rachel Reeves’s decision to hike business taxes, are prompting companies to shed staff and scale back investment as consumer demand softens.

According to December’s flash composite purchasing managers’ index (PMI) from S&P Global, business activity largely stagnated, remaining unchanged at 50.5 and hovering just above the critical 50-point threshold that separates growth from contraction. The survey results fell short of analysts’ expectations and signal that the robust expansion experienced earlier this year has dissipated.

Economists at Capital Economics suggest that the current PMI data is consistent with the UK economy contracting by as much as 0.3% quarter-on-quarter in the final months of 2024, raising the risk that Britain could enter a recession early next year. Two consecutive quarters of shrinking output define a recession, and recent indicators point to a challenging near-term outlook.

However, some analysts caution against reading too much into the PMI figures. Matt Swannell, chief economic advisor at EY ITEM Club, notes that the index tends to overreact to changes in sentiment, which has tumbled since the Chancellor’s late-October budget announcement, rather than reflecting underlying economic activity. Others add that the PMIs do not fully capture the impact of the government’s £70bn increase in public spending, which many expect to boost GDP growth and soften the blow of weaker private sector investment.

Encouragingly, the services PMI—a crucial bellwether for the economy’s largest sector—rose from 50.4 to 51.4, beating forecasts and hinting that the UK’s dominant industry could be regaining momentum. This improvement offset a drop in the manufacturing PMI, which declined to an 11-month low of 47.3 from 48 in November.

Economic data released earlier this month showed an unexpected 0.1% dip in GDP for October, confounding analyst predictions of modest growth. Businesses have reportedly been postponing investment and hiring decisions amid uncertainty over the Chancellor’s policies, including a planned increase in employers’ National Insurance contributions from 13.8% to 15% next April.

The labour market has been the biggest casualty of this uncertainty, with companies now cutting roles at the fastest pace since 2009, excluding pandemic-related downturns. KPMG and the Recruitment and Employment Confederation reported a sharp drop in job vacancies in October and November, further highlighting employers’ reluctance to commit to new hires amid rising costs and shaky demand.

Commenting on the data, Chris Williamson, chief business economist at S&P Global Market Intelligence, said: “UK business confidence has taken a hit, as employment slumps and inflation resurges. The upbeat sentiment from earlier in the year has faded as firms and households respond to the new Labour government’s more downbeat messaging and policies.”

Still, there may be room for optimism. A survey by GfK found that consumer confidence picked up in November and December, suggesting that households could be adjusting and regaining their footing now that future tax and spending plans are clearer. Similarly, the reacceleration in services activity may point to the beginning of a stabilization, as the sector typically responds closely to improvements in consumer sentiment.

Inflationary pressures persist, however, with private sector firms pushing through the fastest price hikes in nine months, especially in services. Economists expect the latest Office for National Statistics data to show that headline inflation rose to 2.6% in November from 2.3% in October, adding another layer of complexity to the Bank of England’s policy decisions. While other central banks around the world are rapidly cutting interest rates, the Bank of England is expected to hold steady at 4.75%, balancing the twin challenges of sluggish growth and stubborn inflation.

Thomas Pugh, economist at consultancy RSM, said: “The Bank of England is caught between a rock and a hard place. Softer growth and higher inflation will likely force it to ease monetary policy only gradually next year. Anyone hoping for an early Christmas present from the Bank at its next MPC meeting is likely to be disappointed.”