January 25, 2011 / 9:35 AM / 8 years ago

Economy suffers shock Q4 contraction

LONDON (Reuters) - The economy suffered a shock 0.5 percent contraction in the last three months of 2010, with unusually poor winter weather accounting for only part of its first shrinkage in five quarters.

Shoppers walk along Oxford Street, in central London December 18, 2010. REUTERS/John Voos

Construction and service sector output — dominant parts of the economy — posted big quarterly falls and the Office for National Statistics said even without the disruption from the coldest December in a century, the economy would have struggled to register any growth at all.

“This is a horrendous figure. An absolute disaster for the economy,” said Daiwa economist Hetal Mehta.

With inflation at 3.7 percent almost double the Bank of England’s target, Tuesday’s shock figures raise the ugly spectre of stagflation and leave the central bank with an acute policy dilemma.

Sterling tumbled by a cent against the dollar on the figures, which showed the economy was in trouble even before the government starts to cut public spending in earnest in 2011.

January’s rise in VAT will only add to the headwinds, suggesting there may be worse to come for the economy.

Gilt prices and short sterling futures jumped as investors dampened expectations that the BoE would opt for an early rise in interest rates to tackle inflation that has consistently exceeded its target for most of the last three years.

Analysts’ consensus forecast was for growth only to slow to 0.5 percent from 0.7 percent in the third quarter, though uncertainty over the impact of December’s snow disruption meant the range of forecasts ranged from 0.1 to 0.6 percent.

“We have been of the opinion that the Bank of England should not raise interest rates until the first quarter of next year,” said Stuart Green, economist at HSBC. “I think the data really confirms the idea that, given the headwind the economy is facing, that this monetary stimulus is still required.”

NO TURNING BACK

Although Tuesday’s data is backward looking, economists said it highlighted how vulnerable growth was to negative shocks — something that will worry the government as it steps up its five-year plan to slash Britain’s budget deficit.

Chancellor George Osborne insisted that the shrinking economy was no reason to deviate from his programme of public spending cuts.

“There is no question of changing a fiscal plan that has established international credibility on the back of one very cold month,” he said.

Separate ONS figures showed Britain’s public sector net borrowing rose from a year ago to its highest December reading on record, though it fell from the all-time record reached in November.

Public sector net borrowing came in at 15.3 billion pounds in December, below the 18.1 billion pounds forecast but above December 2009’s total of 14.3 billion pounds.

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