The latest Office for National Statistics data were far worse than expected and vindicated last week's surprise decision by the Bank of England to cut UK interest rates by 0.5 percentage points, analysts said.
As well as revealing sharp falls in manufacturing activity, the ONS figures provided further evidence of deflation in the sector. Manufacturing output prices fell in December for the first time on record, as weak consumer demand squeezed margins.
John Redwood, the Conservative spokesman for trade and industry, warned that manufacturing was "lurching towards disaster". The Government, however, defended its economic track record, saying it was steering a course of stability through difficult times.
Ken Wattret, an economist at Paribas, said: "The official production data is belatedly catching up with business surveys, which have been screaming recession for months now".
According to the ONS, manufacturing output dropped 0.6 per cent in December, compared to expectations of a 0.2 per cent drop. Output in the sector has now fallen for five successive months, the longest period of successive monthly declines since the early 1980s.
During the last quarter of 1998, the manufacturing sector shrunk by 1.3 per cent, its sharpest quarterly contraction since early 1991. This was the second consecutive quarter of manufacturing decline, the ONS said, meaning that the sector is now officially in recession.
Industrial production, which includes mining and energy production as well as manufacturing, fell by 0.8 per cent in December. Weakening consumer demand has hit manufacturing prices, with the sector now firmly in the grip of deflation, economists said.
In December, producer output prices fell by 0.1 per cent, the first monthly fall since records began in 1958. Manufacturing output prices remained unchanged in January, the ONS said. Input prices rose in January by 0.5 per cent following a recovery in crude oil prices.
City analysts warned the weak data were likely to prompt downward revisions to last year's official growth figures, and could mean that growth turns negative in the first quarter of 1999. Mr Wattret said: "It's quite possible we could have negative growth. The manufacturing data tells us that the problems are deep-rooted."
There were encouraging signs elsewhere in the economy yesterday, with two separate surveys providing evidence of a revival of optimism.
The British Retail Consortium survey pointed to a bounceback in retail sales in January, with like-for-like sales up 2.5 per cent as heavy discounting tempted customers back to the shops.
The apparent contradiction between yesterday's upbeat BRC survey and last week's gloomy Confederation of British Industry survey could be down to differences in measurement, according to Pam Webber, BRC economist. The CBI survey is based on retail expectations, while the BRC survey measures cash through the till.
Meanwhile, the monthly Merrill Lynch/Gallup survey revealed an upturn in optimism among UK fund managers. One in three expect a stronger economy a year from now, compared with just 3 per cent back in September. Asset allocation is moving away from bonds and cash and back into equities, Merrill Lynch said.