Financial services firms are the backbone of Manhattan office demand. But the growing prospect of widespread layoffs in the finance industry could put the brakes on this vital absorption driver in coming months.

Leasing momentum may already have slowed down. Cushman & Wakefield reports that leasing activity in Manhattan through the first nine months of 2007 measured just 18.3 million sq. ft., down roughly 2.5 million sq. ft. (or 12.3%) from the same period in 2006.

Until recently, of course, relying on financial services firms wasn’t such a bad thing: As deal-crazed private equity funds and investment banks jockeyed for space, scores of midtown Manhattan office landlords achieved effective rents topping $100 per sq. ft.

Finance firms occupied roughly 34% of all Manhattan office space at the end of September, reports Cushman & Wakefield. These tenants also drove the top-end of the leasing market: Nine leases priced at more than $150 per sq. ft. were signed during the third quarter, for example, and seven of those leases were signed by financial services firms.

But the ongoing credit crunch has left many finance firms in a precarious position. Yesterday, for example, Morgan Stanley announced plans to cut 600 jobs within its residential lending arm. UBS also announced plans on Monday to cut 70 jobs from its U.S. structured finance business.

Back in August, Lehman Brothers trimmed roughly 2,500 jobs from its residential mortgage division as well. While these 3,100 jobs weren’t all based in Manhattan, the point is that many Wall Street firms are retrenching.

One major downtown office tenant, investment bank Merrill Lynch, has reportedly put its long-discussed expansion plans on hold until the credit markets bounce back. The bank was outgrowing its office space within the World Financial Center, a massive office complex west of Ground Zero on the Hudson River.

Joseph Harbert, chief operating officer of Cushman & Wakefield’s New York Metro Region, says that less leasing activity makes sense given that Manhattan has little new office space coming on line. Plus, adds Harbert, the vacancy rate in Manhattan at the end of last week was just 5.7%, which shows that most of the city’s office inventory is occupied.

And what about sublease space, which typically hits the market when tenants cease hiring new staff or begin downsizing? Sublease vacancy stood at just 1% at the end of September, and that was down from 1.3% just 12 months earlier, according to Harbert.

Manhattan’s office leasing prospects will come into sharper focus over the next few weeks. During the week of Oct. 15, for example, no fewer than four global investment banks with extensive exposure to the residential subprime market will unveil third-quarter earnings. The quartet includes Citigroup, J.P. Morgan Chase, Bank of America and Wachovia. All of these companies occupy sizeable amounts of office space in midtown and downtown Manhattan.

A seasonal factor may compound the problem, too: “A lot of the financial services firms tend to cut their work force during the fourth quarter,” says Kenneth McCarthy, managing director of research in the New York Metro Region for Cushman & Wakefield. “And there’s a lot of uncertainty right now about what will happen next.”