GDP plunge sparks double-dip recession fears

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Fears of a double-dip recession in the UK heightened today after official figures revealed the economy unexpectedly shrank in the fourth quarter.

The severe weather last month was blamed for the shock 0.5% plunge in gross domestic product (GDP) between October and December, the Office for National Statistics (ONS) said, and was driven by a decline in the key services sector - which makes up more than 75% of the total economy.

Analysts warned the surprise decline - the first since the third quarter of 2009 - seriously damaged prospects for the economy as it takes the strain of the Government's sharp austerity measures.

Chancellor George Osborne, however, remained defiant and said the coalition would not allow his plans for fiscal tightening to be "blown off course by bad weather".

The City was alarmed by the figures as the FTSE 100 Index and pound both dropped while pressure mounted on Bank of England governor Mervyn King, who is tasked with taming high inflation and supporting growth. Mr King is due to deliver a speech in Newcastle later today.

Economists were expecting growth of between 0.2% and 0.6% in the fourth quarter but warned that the adverse weather made it difficult to provide accurate forecasts.

Even without the Arctic conditions, the ONS said growth in the fourth quarter would have been flat quarter-on-quarter.

The contraction in GDP shows the economy has weakened just as the Chancellor rolls out his £81 billion package of spending cuts, which include hundreds of thousands of public sector job losses.

Economists warned the fall in GDP output has shaken confidence in the ability of the private sector to pick up the expected slack in the economy and hold off a double-dip recession - defined as two consecutive quarters of economic contraction.

Jonathan Loynes, chief European economist at Capital Economics, described the figures as "shockingly bad".

He said: "Although heavily affected by the weather, the UK's shockingly bad fourth quarter GDP figures - showing a 0.5% quarterly contraction - raise serious concerns over whether the economy is in a strong-enough position to withstand the fiscal tightening."

Mr Loynes expects the economy to rebound in the current quarter, as it did after poor weather in the fourth quarter of 2009, but other adverse forces, not least the impact of the latest VAT hike, could limit the size of the bounce.

Elsewhere, data released by the ONS revealed a lower-than-expected increase in Government borrowing in December - of £16.8 billion - but the Treasury insisted its fiscal tightening plans were vital.

Commenting on the economic growth figures, the Chancellor said: "These are obviously disappointing numbers but the ONS has made it very clear that the fall in GDP was driven by the terrible weather in December.

"We have had the coldest weather since records began in 1910 and this has clearly had a much bigger impact on the economy than anyone expected.

"It's notable that sectors of the economy that are less affected by the poor weather, such as manufacturing, continue to perform strongly, helping to rebalance our economy.

"There is no question of changing a fiscal plan that has established international credibility on the back of one very cold month. That would plunge Britain back into a financial crisis."

The services sector took a severe hit in the fourth quarter, declining 0.5%. Total growth in 2010 stands at 1.4%, far below analysts' forecasts.

Alarm bells over the impact of the winter weather last month have been ringing throughout January as retailers, housebuilders and transport firms revealed a slump in activity as the big freeze took hold.

Last week, the ONS revealed that retail sales in the UK suffered the worst December on record as the high street battled with freezing temperatures and heavy snowfall.

The construction blip, which posted growth in the second and third quarters of 2010, ended in the fourth quarter with construction output plummeting 3.3%. There was some reprieve for manufacturing as production output rose 0.9% in the quarter.

Howard Archer, chief UK and European economist at IHS Global Insight, said the GDP figures added weight to the argument against an interest rate hike, which had been looking more likely as stubbornly-high inflation continues to soar.

Last week, the ONS revealed the Consumer Prices Index (CPI) rate of inflation rose to 3.7% in December, pushed higher by rising food and petrol bills.

Mr Archer said: "The data add major support to the argument that the Bank of England should keep interest rates down at 0.50% despite current elevated inflation levels.

"Given that the contraction in GDP in the fourth quarter occurred even before the fiscal tightening had really kicked in, it reinforces already serious concern over the economy's ability to grow significantly in the face of the spending cuts and tax hikes that will increasingly bite as 2011 progresses."