Manufacturers in the UK have cut back output at the fastest rate in 11 months, compounding the gloomy picture for the British economy, according to a closely watched survey.

The purchasing managers’ index for manufacturing fell in December to 47, down from 48 in November – its weakest reading since February. Any reading below 50 signals a contraction.

The latest evidence of industrial weakness underlines the challenge facing Labour, as it hopes for an economic upturn.

S&P Global Market Intelligence, the data company that compiles the PMI, blamed government policy for the manufacturing squeeze.

Rob Dobson, a director at S&P Global, said: “Manufacturers are facing an increasingly downbeat backdrop. Business sentiment is now at its lowest for two years, as the new government’s rhetoric and announced policy changes dampen confidence and raise costs at UK factories and their clients alike.”

He added that small- and medium-sized companies were being hit hardest. The survey showed that staffing levels were being cut back at their fastest rate since February.

Businesses are facing higher tax bills from April, after the chancellor, Rachel Reeves, announced an increase in employers’ national insurance contributions (NICs) to fund public services.

The NICs increase, which is project to raise £25bn by the end of this parliament, will coincide with a rise in the national living wage of almost 7%, to £12.21 an hour for the over-21s.

“Some companies are acting now to restructure operations in advance of the rises in employer national insurance and minimum wage levels in 2025,” Dobson said.

Labour came to power at July’s general election promising to fix the foundations of the economy and produce the strongest sustained growth among the G7 countries.

With little evidence of improvement, Keir Starmer has more recently switched the focus to improving living standards. In his new year message, the prime minister said voters would see “more cash in your pocket”.

The economy had already been expected to slow in the second half of last year, as the Bank of England kept interest rates high to tackle inflation. Uncertainty over the impact of Donald Trump’s re-election is also likely to have compounded the pessimistic mood.

Revisions to gross domestic product figures published by the Office for National Statistics in late December showed the economy flatlined in the third quarter of 2024. The Bank expects GDP to have stagnated in the final three months of the year, too.

The combination of weak GDP and strong wage increases has sparked fears that the UK may be sliding into stagflation – weak economic growth and rapidly rising prices. This would present a tough challenge for policymakers.

The Bank’s nine-member monetary policy committee (MPC) reduced interest rates to 4.75% in November, with policymakers expected to monitor the impact of the NICs increase closely.

Business groups responded with dismay to Reeves’s budget package of tax increases – and some have called on Labour to water down plans for stronger workers’ rights.

The CBI said in December that the economy was “headed for the worst of all worlds”, projecting a “steep” decline in activity in the first quarter of this year.