(Bloomberg) -- Britain’s private sector companies shed workers at the fastest pace since the pandemic and the depths of the financial crisis, underscoring the Bank of England’s decision to halt interest rate increases for the first time in almost two years.

S&P Global’s composite Purchasing Managers’ Index slipped to 46.8 in September from 48.6 the month before, the sharpest decline in output since January 2021 when the UK was in lockdown. The reading was worse than economists expected and plunged the private sector deeper into contraction territory. 

The survey was cited in the BOE’s decision to hold interest rates at 5.25% as evidence that Britain’s already sputtering economy was weakening. The central bank had an early look at the indicator before its decision, which economist said may indicate that borrowing costs have peaked for now.

The PMI adds to a growing list of indicators that point to a lackluster second half of the year for the economy. Retail sales data also out Friday showing a smaller-than-expected bounce back in August. That suggests retail may be a drag on gross domestic product figures for the third quarter — unless September delivers a big bounce higher.

The closely-watched survey adds to concerns that the UK is heading into downturn a little more than a year before the deadline for the next election. That’s a concern for Prime Minister Rishi Sunak’s government, which is trailing in polls and is hoping to spark growth before voters got to polls. 

The PMIs signaled a second straight month below the 50 threshold separating growth and contraction and point to a downturn in GDP. Further weakness in services, the UK’s largest sector, dragged on activity. 

More signs the labor market is loosening adds to confidence the Bank of England’s fight against inflation is gaining traction, and that it could soon stop raising interest rates. The outlook is weighing on the pound and spurring a rally in gilts, with 10-year bonds on track for their longest streak of weekly gains in two years.

The currency weakened as much as 0.5% to $$1.2233 on Friday, extending the biggest decline across Group-of-10 peers this month. Traders put the chance of a one final quarter-point hike at just 70%, according to swaps pricing.

“A recession is looking increasingly likely in the UK,” said Chris Williamson, chief business economist at S&P Global Market Intelligence. “A major concern in the inflation outlook has been wage growth, but with the survey now signaling the sharpest fall in employment since 2009, wage bargaining power is being eroded rapidly.”

S&P also said there had been an “abrupt turnaround” in the jobs market, with staff cuts the fastest since October 2009, excluding lockdowns during the pandemic. 

“It’s clear from the weak survey data this morning that the effect of the prior interest rate hikes is starting to bite,” said Mike Bell, global liquidity market strategist at J.P. Morgan Asset Management.

What Bloomberg Economics Says ...

“The UK PMI slipped further into recessionary territory in September, suggesting output could contract modestly in the third quarter. The survey poses a risk to our view that the economy will expand in 3Q before falling into a shallow recession later in the year — the downturn may have already begun.”

—Ana Andrade and Dan Hanson, Bloomberg Economics. Click for the REACT.

S&P said that private sector business activity fell at the steepest pace since March 2009, aside from the pandemic. Businesses blamed the cost-of-living crisis and higher interest rates for the subdued demand.

While the economy is weakening, there was more evidence of inflation cooling. Input price inflation saw its biggest monthly fall in 2023 so far.

Separate figures on retail sales for August showed a partial recovery from a weather-related slump in July but probably not enough to reverse a declining trend. Volumes rose 0.4% in the month after a 1.1% drop the month before. 

The sharp decline in July means retail sales are on track to be a drag on third-quarter gross domestic product, unless September shows a gain of 1.4% or more. That reflects headwinds on the economy coming from high inflation and interest rates, and a cost-of-living squeeze that’s only starting to relent.

A surge in retail prices over the last 18 months means consumers are paying more to buy fewer goods for their money. The value of sales in August was 17% above pre-pandemic levels in February 2020, while the volume of those sales 1.5% below.

“With the impact of higher interest rates continuing to build, retail growth in the third quarter is likely to be sluggish, in line with the wider economy,” said Martin Beck, chief economic advisor to the EY ITEM Club.

The gloomier economic data in recent weeks is yet to weigh on household sentiment, a new survey showed on Friday. 

GfK’s consumer confidence index rose 4 points to minus 21 in September, the strongest level since January 2022 before the Russian invasion of Ukraine triggered a surge in energy bills. The survey shows confidence has recovered sharply from the record lows recorded in September last year with households much more upbeat about the outlook for their personal finances.

--With assistance from Andrew Atkinson, Alice Gledhill and Constantine Courcoulas.

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