Factory slump shows no quick end to recession
LONDON (Reuters) - The manufacturing sector shrank at its fastest rate in more than three years in July, a survey of purchasing managers showed on Wednesday, dealing a blow to hopes that the country was about to come out of recession.
The grim news supports the view that the Bank of England will add further stimulus once its current 50 billion pound plan to buy government bonds with newly created cash ends in November. It even triggered speculation the central bank could step up its programme when its August policy meeting ends on Thursday.
Britain fell into its second recession in four years around the turn of the year, and the economy contracted by a further 0.7 percent from April to June due to government spending cuts, euro zone turmoil, bad weather and an extra public holiday.
Many economists have been betting that some of the output lost will be recovered in the third quarter, but the Markit/CIPS Manufacturing Purchasing Managers' Index's (PMI) drop to 45.4 from 48.4 in June raises the risk of another contraction.
It was the lowest reading since May 2009, further off the 50 mark that separates contraction from growth, and well below even the most pessimistic economist's forecast in a Reuters poll.
The weak survey sent sterling to a two-week low against the euro and supported gilts which outperformed their German equivalent.
"Pretty terrible, surprisingly bad," Tom Vosa, an economist at National Australia Bank, said about the PMI. "Ultimately, this puts more pressure on the Bank to cut Bank Rate, and certainly the government now has to hope that its Funding for Lending Scheme really comes good," he said.
"But of course, if you are a lender in the UK and you are looking at this economy, why would you necessarily want to extend credit?," he said.
The government's scheme to get credit flowing through the economy officially started on Wednesday.
Business lobby groups applauded the plans to boost lending, but economists warned against putting hopes too high.
The scheme was an important step to lower banks' funding costs and ease lending conditions, but was unlikely to be a "game changer", Goldman Sachs analyst Kevin Daly said in a note.
Tight credit together with a lack of consumer confidence has been a major drag on the economy, hitting the housing market particularly hard.
House prices fell at their fastest annual pace in nearly three years in July, mortgage lender Nationwide said.
However, some retailers are bucking the gloom: Britain's second-biggest clothing retailer Next's sales rose 4.5 percent in the six months to July 28, and its chief executive said he did not expect the economy to take a turn for the worse.
Britain's economy has not yet recovered the output lost during the 2008/2009 slump, and the renewed recession comes at a time when many Britons are seeing their finances squeezed by rising prices and higher taxes, eating away measly wage rises.
"The domestic market shows no real signs of renewed life, while hopes of exports charting the course to calmer currents were hit by our main trading partner, the euro zone, still being embroiled in its long-running political and debt crises," said Markit economist Rob Dobson.
The PMI survey showed that export orders fell at the sharpest rate since the height of the financial crisis in February 2009, and the output index slumped to 43.3 from 51.9, also the lowest level in more than three years.
"It looks like the sector remains a major drag on the overall economy," Dobson said.
The slump in manufacturing is also keeping the pressure on policymakers to get the economy going again.
The government sees no room for a major spending boost, having pledged to erase a huge budget deficit within the next five years, thus leaving the onus on the central bank.
Most economists expect an extension of the Bank's purchases of government bonds beyond the current goal of 375 billion pounds in November, but some see a chance of earlier action.
"While we accept it is a close call, we believe that the extent of the revisions to the Bank's projections mean that the Bank will not wait until November to expand QE further - rather it will act at this meeting," said Alan Clarke from Scotiabank.
The Bank looks likely to slash its inflation and growth forecasts in its August inflation report, which governor Mervyn King will present next week.
The PMI survey showed that companies' cost pressures eased as prices for chemicals, oil, metal, paper and plastics fell. But firms still hiked their selling prices, Markit said.
Consumer price inflation has fallen sharply in recent months and the British Retail Consortium said on Wednesday shop prices rose at the slowest pace in more than 2-1/2 years in July.
(Additional reporting by Olesya Dmitracova and David Milliken. Editing by Jeremy Gaunt.)
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