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.
The contraction in industrial production in May was driven by a much sharper than expected fall in manufacturing output, down 0.5 percent on the month and 0.8 percent on the year.
The ONS said high temperatures did little to help either. Electricity, gas and water output were down 5.2 percent, the biggest fall since October 2001.
With official data echoing other evidence, the first estimate of second quarter GDP on July 20 is likely to show slower growth again. This would follow a deceleration to 0.3 percent quarter-on-quarter growth in the first quarter.
Retail sales have shown remarkable strength despite sinking consumer confidence and a housing market downturn. But economists do not expect this to last, removing the last element of doubt from forecasts of a sharp economic slowdown.
Purchasing managers’ surveys indicate the economy is already in recession territory although the National Institute of Economic and Social Research estimate growth ticked higher to 0.2 percent in the three months to June from 0.1 percent in May.
Nonetheless, cracks are showing in the labour market. Official statistics show unemployment on the rise and a report on Thursday by REC/KPMG showed vacancies for full-time staff fell in June for the first time in five years.
“The bad news on the UK economy continues to accumulate, heightening fears that the UK could enter into a mild recession if consumer spending buckles in coming months,” said Matthew Sharratt, an economist at Bank of America.
But with inflation is at its strongest level since the Bank of England won the power to set interest rates in 1997, no change in official borrowing costs is expected when the MPC meets this week.
Editing by Mike Peacock