Business activity in Britain slowed less than expected in March, a closely watched survey showed, but waning optimism in manufacturing and services, coupled with surging inflation, suggested “stagflation” was likely in the coming months.

The S&P UK PMI, which measures the health of the services and manufacturing sectors, fell to a two-month low of 59.7 in March from 59.9 in February.

However, the figure still beat the 57.8 forecast by economists polled by Reuters, well above the 50 mark, indicating that most businesses reported growth.

Chris Williamson, chief business economist at S&P Global, said the survey showed the economy’s continued strong pace of expansion, as economic activity following the end of Covid-19 restrictions helped offset headwinds from the war in Ukraine, Brexit and rising prices.

But he also warned that “growth is likely to slow sharply in the coming months, with inflation accelerating further and the cost of living crisis worsening, painting an unwelcome picture of ‘stagflation’ for the economy in the months ahead” .

Stagflation Refers to an uncommon period of slow growth combined with high inflation.

On Wednesday, fiscal watchdog the Office for Budget Responsibility cut Britain’s growth outlook for this year to 3.8% from 6% in October after real household income fell to its lowest level since records began in 1957.

Escalating inflationary pressures and fears of a Russian invasion of Ukraine led to a slump in business optimism, which fell to a 17-month low this month, the PMI survey showed.

In addition, soaring fuel, energy and staff costs have led companies to charge their highest prices since the index began in November 1999.

PMI readings based on data collected from March 12-22 showed that the average cost burden rose sharply in March, indicating that inflation was the second fastest in more than two decades.

Growth in the services sector was stronger than expected, helped by the lifting of Covid-19 restrictions and the return of people to offices, as well as the release of pent-up demand for travel, leisure and entertainment.

However, this was offset by a slowdown in manufacturing output, which fell to a five-month low as supply shortages and escalating inflationary pressures dampened demand.

Growth in new manufacturing orders fell to the weakest level since lockdowns resumed in January 2021, weighed down by weak domestic demand.

Gabriella Dickens, an economist at Pantheon Macroeconomics, said the PMI was in line with UK first-quarter gross domestic product (GDP) growth of 1%.

However, she added: “Second-quarter GDP is likely to fall by about 0.2% as coronavirus-related health care spending tapers off and the contraction in real incomes intensifies in April.”

In the euro zone, euro zone activity slowed to a two-month low as the economic fallout from Russia’s invasion of Ukraine offset a boost to consumer demand following the lifting of Covid restrictions.