The sprawling services sector, accounting for two thirds of Britain's economy, may be shrinking at its fastest pace since 1979, when Margaret Thatcher came to power.

A drastic slump in a key gauge of conditions facing services businesses last month, to the lowest level since it began in 1996, pointed to the crucial sector contracting at a rate of up to 1.2 per cent in the final three months of this year — three times as fast as the 0.4 per cent slump already suffered in the third quarter, economists said.

Fears that Britain is sliding into a recession that may be more severe than that of the early Nineties were fuelled as the latest CIPS/Markit index of services sector activity plummeted last month to a record low of 40.1, down from 42.4 in October, on a scale where any reading under 50 indicates contraction.

Anxieties over the deepening plight of services companies, from business services providers to leisure businesses such as hotels and restaurants, were heightened as the report showed that levels of outstanding business in the sector and inflows of new business both plunged last month to the lowest levels in the survey's 12 and a half year history.

In grim findings that further stoked concerns that unemployment is set to soar throughout next year, the results indicated that services businesses are responding to their rapidly worsening fortunes by cutting staff at the fastest pace in more than ten years.

Services groups' confidence in future business conditions also succumbed to a steep decline last month, with the survey's index of the sector's sentiment dropping below the “no-change” threshold of 50 for the first time.

“This is a desperately worrying survey, given the importance of the dominant services sector to the economy,” Howard Archer, of IHS Global Insight, an economic consultancy, said. “The heightened financial sector crisis has obviously taken a particularly heavy toll on the services sector, while the deep housing downturn, and markedly reduced consumer spending, is also hitting the sector hard.”

Consumer spending fell in the third quarter by 0.2 per cent, on the heels of a 0.1 per cent drop in the previous three months, according to official figures. This marked the first back-to back quarterly declines in consumer spending since the depths of the early Nineties' recession and the steepest fall in a single quarter since the start of 1995.

The huge shift in services businesses' fortunes - and the looming threat of deflation haunting the City, Bank of England and the Treasury - was emphasised as yesterday's survey also revealed that they have responded to slumping demand with a wave of aggressive price cuts.

The survey's measure of prices charged by services groups tumbled to a seven-year low of 49.2 last month, down from 51.6 in October. The figures suggested that prices in the sector are actually falling for the first time since 2001, during the economy's last significant slowdown.

At the same time, cost increases for services companies also slowed markedly, rising at the slowest pace seen since 2002.

“This provided clear evidence that inflationary pressures are disappearing fast,” Mr Archer said.

The emerging frailty of services businesses was broadly based last month, as the recession cut a swath across the sector, yesterday's CIPS/Markit report indicated. The most acute declines were felt, however, in the transport and communications industries and in the financial services sector, where the credit crunch and banking crisis have undercut conditions and are leading to aggressive cost and staff cuts.

Explore Economics

• Pre-Budget Report 2008

• Budget 2009

• World Economic Forum

• The Times MPC

Times Recommends

• Lies and cover-up at MG Rover exposed by report
• High oil prices push manufacturing costs up
• Primark founder steps down as chief executive