British economy 'could relapse into recession'

Britain's already sluggish and fragile economic recovery is set to lose more momentum and may relapse into recession, according to the latest surveys of business confidence and economic forecasts from the British Chambers of Commerce (BCC) and the Institute of Directors (IoD).

The IoD warns that Britain is in for "one L of a recovery", as a rapid fall in output in 2009 is followed by broadly flat, stagnant growth this year and next, with the economy dipping in and out of negative territory.

"The recovery is likely to be characterised by a weak upward gradient, with a 'ratchet' effect and quarters of acceleration, deceleration and even decline," the IoD says.

The June survey of the service sector – comprising 70 per cent of the economy – by the Chartered institute of Purchasing and Supply (Cips) indicates that growth may have been stronger than expected in recent months, but future prospects may be dimmer than were previously hoped for.

Speculation about public spending cuts and the reality of the toughest Budget since the Second World War, delivered by the Chancellor on 22 June, has had a marked impact on consumer and business confidence.

The fall in the headline business activity index, from 55.4 to 54.4, was the third monthly drop since February's recent peak, leaving the balance at its lowest level since August. While still in positive territory – any reading above 50 indicates expansion – the trend is down. The Cips survey is regarded as a reliable leading indicator for the real economy, with about a six to nine-month lag.

The Cips warned: "The output index from the combined surveys of manufacturing, services and construction reached a peak in February, and has since assumed a downward trend.

"Historically, the level of the index is still consistent with gross domestic product (GDP) growth of 0.7 per cent to 0.8 per cent in the second quarter, but because the index excludes some sectors which we expect to be weak contributors to GDP in Q2, notably retail and government, growth is perhaps more likely to be 0.5 per cent to 0.6 per cent."

The BCC also voiced longer-term concerns. Its director general, David Frost, said: "Despite an improvement in manufacturing, the sector still faces serious risks. Given the sector's poor long-term historical record, it is much too early to conclude that we are now seeing a sustainable manufacturing upturn. The service sector, which accounts for the bulk of GDP in the UK, is not recovering at an adequate pace and this heightens the threat of an economic setback."

Much may now depend on the resolution of the eurozone's sovereign debt crisis and associated concerns about its banking system. As Britain's largest trading partner – the UK exports more to Ireland than to China, India and Russia combined – the health of the single currency area is crucial if the depreciation of the pound is to trigger an export-led recovery.

The BCC said exporters were benefiting from more competitive exchange rates but added: "The service sector's export balances recorded modest increases and they remain weak by historical standards."

In a notably downbeat assessment of future prospects, the IoD identified still more potential weaknesses, including falling house prices, less lending by banks to small enterprises, and consumers saving more money rather than spending.

Graeme Leach, the chief economist at the IoD, said: "After a very abnormal recession, it would be foolish to rule out the possibility of a very abnormal recovery."