Pressure for rate cut as crunch bites harder

The gloomy purchasing managers' index of service sector companies such banks, travel and insurance companies came just a week before the Bank of England's next decision on interest rates, and highlights its dilemma of slowing economic growth and rising inflation.

It came as it emerged that even the archly conservative Co-operative bank had fallen victim to the credit crunch with profits collapsing almost £26 million to £50.3 million due to a £31.8 million writedown on the value of structured investments hit by the financial crisis.

Service industries are the mainstay of the British economy, particularly in London and the South-East, and have so far been robustly staving off recession in the country. But today's PMI survey showed a far bigger fall in growth during March, plus a big drop in companies' confidence about the outlook.

"This sends a similar message to that from manufacturers - a slowing growth trajectory," said JPMorgan analyst Allan Monks.

While there was still growth, its pace slowed significantly as new orders fell off far more than expected. Prices, on the other hand, remained at about the highest levels since 1996, highlighting concerns in some quarters about the threat of "stagflation" - low economic growth and spiralling inflation.

"It all heaps pressure on the Bank of England to cut interest rates again next Thursday despite elevated inflation concerns," said Howard Archer, Global Insight economist.

News of the Co-op's profits fall, which came a day after it joined the ranks of lenders withdrawing their best mortgages, came as a shock to many people who regard the bank as one of the most risk-averse in the UK with all its mortgage lending covered by savers' deposits.

Today it said: "Our funding is over-whelmingly from retail and corporate deposits rather than from the financial markets, and our reliance on wholesale funding is lower than most other banks. The quality of our mortgage book remains high and we have continued to reduce our exposure to unsecured assets."

Chief executive David Anderson said the writedowns accounted for slightly more than half the bank's holdings in mortgage-backed securities issued by major international banks like Citi and HSBC. He said such holdings were now down to just £30 million.

In fact, Co-op bank's normal impairment charge - the amount it writes off for bad loans and debts - actually fell slightly from £105 million in 2006 to £102 million last year. But the impairment losses on structured investments went from nothing to £31.8 million.

The bank results are now incorporated into the larger Co-operative Financial Services, which today said profits rose 6.3% to £155 million with a big rise in insurance profits despite its suffering £37.9 million of claims from last year's flooding.