Companies in the UK’s dominant services sector have reported one of the sharpest declines in business activity in a decade, according to a closely watched index.

Businesses are grappling with a “perfect storm” of domestic political uncertainty around Keir Starmer’s leadership as prime minister and the growing impact of the Iran war, leading to soaring costs, supply shortages and job cuts, the report said.

The S&P Global purchasing managers’ index (PMI), which surveys hundreds of companies across the UK each month, said activity among firms working in the services sector was the weakest since January 2021 and the lowest since July 2016 if the Covid pandemic period was excluded.

The services sector, which ranges from hospitality and retail to finance and IT, accounts for about 80% of the UK economy, meaning its performance has a significant effect on GDP growth.

The downturn affected the PMI’s “composite output index”, which scores how private companies across the manufacturing and services sector are performing, with a reading above 50 meaning growth in business activity, while anything below represents contraction.

It gave a score of 48.5 for May, down from 52.6 in April. This was much worse than the 51.6 score forecast by economists and the lowest since April 2025.

Andrew Wishart, an economist at the German bank Berenberg, said if the slump in the PMI were to continue, it would point to “GDP growth collapsing”, from an expansion of 0.6% in the first quarter of this year to -0.2% in the second quarter.

Chris Williamson, the chief business economist at S&P Global Market Intelligence, said: “The blame lies first and foremost with the war in the Middle East, though companies are also noting that domestic politics are taking an increasing toll, driving uncertainty higher, in turn deterring spending, hiring and investment.”

The index also showed private sector payroll numbers falling for the 20th successive month, largely because of “a faster pace of job shedding” in the services sector. This mirrors data released from the Office for National Statistics this week, which showed the number of payrolled employees dropped at the sharpest rate since 2014 in April, falling by 100,000, after a 28,000 decline in March.

The fall in services sector activity outweighed an upturn in UK manufacturing. Companies said customers had been “front-loading” orders in an attempt to beat future price rises and potential supply disruptions. This contributed to activity in manufacturing accelerating to a three-month high, despite international shipping delays in the Gulf causing some supply chain issues.

However, a separate report from the Confederation of British Industry, the business lobby, said manufacturers were reporting their lowest order books since 2020 in May and expected demand to fall further in the next three months, suggesting a mixed picture in the sector.

Economists said May’s PMI survey was the latest data to suggest the Bank of England could probably hold off raising interest rates from 3.75% at its next meeting in June. Official figures this week showed that the rate of inflation in the UK slowed to 2.8% in April from 3.3% in March, while wage growth slowed to 3.4%, suggesting the economy was not suffering from runaway inflation yet.

Paul Dales, the chief UK economist at Capital Economics, said: “By showing that weaker activity may be starting to restrain price rises, May’s flash PMIs are the third set of figures in three days that suggest the Bank of England does not need to rush to raise interest rates.”