Recession fears grow on factory output data

By Matt Falloon and Sumeet Desai

LONDON (Reuters) - Industrial output fell at its sharpest pace in 2-1/2 years in May, official data showed on Monday, raising fears that economic growth is freezing up.

The weak reading weighed on sterling as investors scaled back their bets that rising inflation would force the Bank of England to raise interest rates this year despite slower growth.

Borrowing costs now seem more likely to remain on hold for a while before falling to bolster the economy, economists argue.

The Office for National Statistics said industrial production fell 0.8 percent on the month, well beyond analysts' expectations of a 0.1 percent decline. This left output 1.6 percent lower on the year, the biggest drop since December 2005.

The figures back up the increasingly gloomy picture painted by more up-to-date surveys which show Britain skirting close to its first recession since the early 1990s.

"The economy is now slowing sharply and is likely headed for a period of outright contraction," Michael Hume, an economist at Lehman Brothers investment bank.

"Once the (BoE) Monetary Policy Committee decides that a recession is more likely than not, we expect it to cut rates," he said. "We think that that will happen only by November, but the chances of an earlier rate cut are not far below 50 percent."

Two successive quarters of economic contraction are regarded as a recession.