Downgrade to growth triggers new fears of a double dip

ONS estimates 0.3 per cent fall between October and December, but trade balance improves

The economy shrank by more than expected in the final three months of 2011, heightening fears that the UK is returning to recession. There was a 0.3 per cent contraction between October and December, according to the Office for National Statistics, a worse figure than the statistics agency's previous estimate of a 0.2 per cent fall in output.

The downward revision came after statisticians identified a greater-than-expected decline in the output of the transport, communications and business services sectors. Financial services also dragged down the figure. The statistics also pointed to an intensifying squeeze on the finances of households, with real disposable income falling by 0.2 per cent over the three months, and by 1.2 per cent over the year as a whole.

"The weakness highlighted in this release in combination with the poor production and retail sales data so far for 2012 make it more likely than not that the economy also contracted in the first three months of this year, which would put the UK in a technical recession," Azad Zangana, a European economist at Schroders, said.

The ONS release, in addition, changed its estimates for growth over the preceding nine months of 2011. In the first quarter of the year growth was revised down to 0.2 per cent and the second quarter was revised down to a contraction of 0.1 per cent. Growth in the third quarter was revised up to 0.6 per cent. The result of all these changes is that the ONS now believes total growth over 2011 was 0.7 per cent, down from its previous estimate of 0.8 per cent.

The ONS's preliminary estimate of GDP for the first quarter of 2012 – which will be published on 25 April – is set to be closely watched. If that produces a negative figure, the UK will officially be back in its second recession in just three years. However, most analysts, encouraged by strong data from business surveys since the new year, are predicting that the economy will turn out to have returned to modest growth in the first three months of this year.

The Chancellor's independent watchdog, the Office for Budget Responsibility, has forecast that the economy will expand by 0.8 per cent over 2012 as a whole. But the Governor of the Bank of England, Sir Mervyn King, yesterday warned that GDP may shrink in the second quarter of this year, partly as a result of people taking time off for the Queen's Diamond Jubilee.

Today's disappointing GDP news was offset by reports of an improvement in the trade balance. Britain's current account deficit shrank to £8.5bn in the fourth quarter of 2011. The ONS also revised down its estimate of the current account deficit in the third quarter of the year to £10.5bn, down from a previous estimate of £15.3bn.

The improvement in the trade balance was driven by a fall of the UK's trade deficit – the surplus of imports over exports – and an increase in investment income from abroad. The UK's trade deficit fell from £8.8bn in the third quarter to £7.1bn in the fourth quarter. The income surplus rose to £4.6bn, up from £4bn over the previous three months.

The statistics agency now believes the overall current account deficit in 2011 was £29bn – an improvement on 2010, when it was £48.6bn.

Howard Archer of IHS Global Insight said: "The fourth-quarter balance of payments data show a much-needed improvement. The economy could certainly do with more of the same in 2012 – an improving net trade performance and a pick up in investment income".