Economy shrinks amid warnings of 'double-dip'

The British economy shrank last month and an already faltering recovery will slow sharply over the coming months, according to the National Institute of Economic and Social Research (NIESR), one of the nation's most respected and accurate forecasters.

The news comes as official industrial production data showed that manufacturing enjoyed a further revival in July, suggesting that the comparatively robust growth in the first half of the year will be matched by an equally marked downturn later, which may lead to a so-called "double-dip" recession.

The NIESR's latest estimates of monthly GDP show that it fell by 0.2 per cent in July, though the monthly data is volatile. Based on the run of figures over the past quarter though, the NIESR detects a distinct slowdown, as output grew by 0.7 per cent in the three months ending in August after a 1.3 per cent expansion in the quarter ending July. Services accounted for the retreat.

The NIESR said: "The pace of economic growth may have softened in the three months to August, but it is still a robust rate for the UK. Unfortunately, the rate of growth will continue to decelerate over the coming months. These recent numbers do not alter our view that the Bank of England's Monetary Policy Committee (MPC) will hold off from raising interest rates until the summer of next year."

Meanwhile, the ONS reported that manufacturing output rose by 0.3 per cent month-on-month in July. This was in line with expectations and matched the June and May outturns. Consequently, manufacturing output was up 4.9 per cent on last year, the best performance since December 1994.

The MPC will announce its latest move on interest rates and "quantitative easing" (QE), the direct injection of money into the economy, at noon today.

The MPC has not altered rates since March 2009 and last adjusted QE in November. Despite this apparent stability of policy, the MPC minutes and public statements show a three-way split on the Committee, torn between those who fear that commodity prices and expectations will push price rises much higher, and those who fear a full-blown deflation may follow a renewed "double-dip" recession.

So far the group arguing that the risks remain balanced has held sway, but the pressures, on both sides, are growing more acute as world food prices spike and confidence appears to be evaporating as public spending cuts make their presence felt.

David Kern, the chief economist at the British Chambers of Commerce, warned: "British business will find it very difficult to drive the recovery without a prolonged period of low interest rates.

"Any consideration of raising interest rates by the MPC should be dismissed until the middle of 2011 at the earliest."