Economy shrinks in third-quarter

By Sumeet Desai and Matt Falloon

LONDON (Reuters) - The economy shrank 0.5 percent in the third quarter of 2008, substantially more than expected and the first contraction in 16 years, official data showed on Friday, making a recession all but inevitable.

With the global financial crisis feeding through to the real economy with ever more impact, economists are agreed that the current quarter is likely to prove as bad if not worse for Europe's second-largest economy, confirming a recession.

The pound fell to its lowest against the dollar in six years and the FTSE 100 index of leading shares dropped nearly 8 percent as the first reading of Q3 GDP among the Group of Seven industrialised nations rattled investor confidence.

Futures markets moved to price in a higher chance the Bank of England would cut interest rates by another 50 basis points in November, following this month's emergency cut to 4.5 percent from 5 percent, the biggest reduction in seven years.

The 0.5 percent drop in gross domestic product in the three months to September was the biggest since the last three months of 1990 and the first contraction since the second quarter of 1992, the Office for National Statistics said.

"It's a very emphatic entry into recession which underlines the need for dramatic rate cuts -- which we think the Bank of England will deliver," said Brian Hilliard, economist at Societe Generale.

"We're looking for a 50 basis point cut in November and a rapid succession of cuts to about 2.5 percent by the middle of next year."

Expectations of those further rate cuts coupled with the weak growth helped drive the pound down sharply. It has lost nearly 20 percent against the dollar in the last month, to stand around $1.55 after trading above $2 for much of last year.