Service sector struggles with falling activity and rising cost pressures
Sentiment across the services sector deteriorated again in the quarter to February, according to the CBI’s latest Service Sector Survey. Business volumes also fell faster for the fourth consecutive rolling quarter. In particular, consumer services saw a heavy fall in volumes, alongside a more tempered, but still significant, decline in business & professional services.
Furthermore, pressures on costs and prices have continued to build in the quarter to February, with prices seeing a firmer increase compared to the second half of 2024. Consumer services recorded a particularly big jump in price inflation compared to the previous quarter, where it is now at its highest since May 2023. In contrast, business & professional services saw a more modest rise in prices in the quarter to February, in line with the pace of inflation seen over the past year.
With business volumes falling, cost pressures picking up and margins remaining depressed, profitability continued to fall sharply across the services sector. Services firms also reported another decline in headcount, albeit at a slower pace than in the previous rolling quarter.
Looking ahead, firms across the services sector expect to see business volumes decline again in the quarter ahead, albeit at a somewhat slower pace. This is driven primarily by business & professional services, which expects the decline to slow compared to the previous quarter. However, consumer services firms anticipate volumes to deteriorate at a similarly heavy pace.
Alongside weak prospects for activity, expectations are for cost inflation to pick up further during the next three months – if realised, this would mark a return to historically high costs growth across the sector. While selling price inflation is also expected to accelerate, it is still set to run behind the predicted rise in costs.
With activity still weak, services firms are being selective about their investment plans over the year ahead. Across the sector, firms expect to cut back significantly on capital spending across the board, with investment plans for land & buildings and vehicles, plant & machinery now at their weakest since the Covid-19 pandemic. The notable exception is IT spending among business & professional services firms, which is anticipated to increase in the year ahead.
Alpesh Paleja, deputy chief economist, CBI, said: “There is little to cheer in the services sector, as companies struggle with falling activity, rising cost pressures, and constrained margins. While businesses are grappling with the rise in employment costs from measures in the Autumn Budget, it’s clear that underlying demand conditions remain weak too. In particular, the much deeper weakness in consumer services firms points to a cautious spending mindset among households.
“Looking ahead, the recent recovery in real household incomes should give a lift to some services companies. Positive plans for IT spend in business & professional services also point to firms prioritising investment in their future. But given how weak our survey data is across the board, it’s clear that more needs to be done to catalyse growth in the UK’s largest sector.
“In a tough economic environment, the government is right to make kickstarting growth a key priority and business stands ready to help it deliver on that pledge. With the right levers in place, like long overdue changes to the Apprenticeship Levy to match skills to economic needs or accelerating to net zero, the sustainable growth essential for raising living standards, improving public services and boosting business confidence can be achieved.”
The survey based on the responses of 517 services firms found that:
Business & Professional Services
- Optimism about the general business situation again fell for the second quarter running, at the joint-fastest pace in just over two years (-28%, from -29% in November 2024).
- Business volumes continued to decline for the third month running (-26%, from -16% in January), with the pace of decline picking up. Volumes are expected to decline again over the quarter ahead, albeit at a slower rate (-14%).
- Growth in total costs per person employed remained elevated in the quarter to February (+46%, from +42% in November 2024). Although growth in costs per person has remained below the record peak seen in 2022 (+69%), it remains historically strong, with the balance standing well above the long-run average (+30%). Cost growth is set to accelerate significantly next quarter (+68%).
- Average selling prices rose modestly in the three months to February (+9% from +6% in November 2024). Again, while well below the peak seen in 2022 (+31%), the balance stands above the long-run average (-3%). Firms anticipate faster price hikes next quarter (+19%).
- Profitability fell strongly (-37%), at the fastest pace since August 2020 (-46%), whilst also marking four years of continuous decline quarter upon quarter. Profits are expected to decline at a similar pace over the next quarter (-36%).
- Headcount declined moderately for the second consecutive rolling quarter (-6%). Headcount is expected to decline moderately again in the quarter ahead (-12%).
- Firms anticipate significant cutbacks in investment in both land & buildings (-21% from -7% November 2024) and vehicles, plant & machinery (-21% from -9% in November 2024). However, firms continue to expect more investment in IT, with spending plans firming in the latest quarter (+19% from +6% in November 2024).
Consumer services
- Optimism about the general business situation continued to deteriorate sharply in the quarter to February (-55%, from -55% in November 2024), marking the joint-fastest decline since August 2022 (-64%).
- Business volumes declined in the quarter to February (-53%), continuing the trend seen through much of the previous three years. Firms expect the decline in volumes to continue at this pace next quarter (-55%).
- Costs continued to rise at a robust pace in the three months to February (+55%, from +44% in November 2024). Firms expect costs growth to accelerate sharply next quarter (+75%).
- Average selling price inflation picked up in the three months to February (+36%) compared to November 2024 (+10%). Average selling price growth is expected to increase more significantly next quarter (+48%).
- Profitability continued to fall solidly, albeit at a somewhat slower pace (-35%, from -41% in November 2024). Nonetheless, this marked four years of continuous decline. Profits are expected to deteriorate over the next quarter, at a faster pace (-55%).
- Employment continued to fall amongst consumer services firms in the three months to February (-35%, from -41% in January), with the balance standing well below the long-run average (+0%). Numbers employed are expected to fall at a faster pace in the three months to November (-53%).
- Consumer services firms expect to make significant cutbacks to investment on land and buildings (-35% from -21% in November 24), vehicles, plant & machinery (-34%, from -28%) and IT (-32%, from -4%).