Fall in factory output lifts rate cut hope

Economy: Manufacturers failing to benefit from Baghdad bounce or fall in pound, official figures show

Advocates of a cut in interest rates this week were handed some last-minute ammunition yesterday in the form of an unexpected fall in manufacturing output in May.

The sector contracted by 0.2 per cent, disappointing economists' forecasts for zero growth and wiping out the benefit of April's 0.3 per cent rise.

The annual rate of decline worsened from April's 1.2 per cent to 2.1 per cent in May, the sharpest fall since October last year.

The biggest fall was transport equipment, down 1.8 per cent, mainly due to a 4.9 per cent fall in car output. Hi-tech electrical and optical equipment - the driving force behind April's rise - contracted 1.3 per cent, with computer output in particular down 4.8 per cent.

Economists agreed that one month's data was unlikely to change minds on the Bank of England's Monetary Policy Committee but used the figures to support their own forecasts of the likely outcome.

Ross Walker, a UK economist at Royal Bank of Scotland, said: "The fall in May will not have come as a tremendous shock and is probably not enough to prompt an interest rate cut on Thursday."

Yesterday's figures have been overtaken by the survey from the Chartered Institute of Purchasing and Supply (Cips) that showed a slight upturn in June.

However Alan Castle, UK economist at Lehman Brothers, said the figures from the Office for National Statistics showed little sign of a boost for manufacturing from the end of the Iraqi war or the fall in the pound.

"There is little scope for a significant rebound more generally in economic growth in the second quarter," he said. "There is a better than evens chance of a 25 basis-point rate cut on Thursday."

The Bank has kept the rates unchanged at a 48-year low of 3.75 per cent since its unexpected cut in February. However, the nine-member MPC has split every month amid signs the economic recovery is not as strong as had been hoped for at the start of the year.

Yesterday the National Institute of Economic and Social Research, an independent think-tank, called for a "precautionary" rate cut.

It estimated the economy grew 0.4 per cent in the three months to June, up from 0.1 per cent in the first quarter of the year.

Although this is an improvement from the rolling three-month growth of 0.3 per cent in May, it is below the Bank of England's assumptions in its inflation forecast. Martin Weale, NIESR's director, said: "With growth below trend, there remains a case for a precautionary reduction in interest rates this week."

The City is split on the outcome, with 28 of 44 economists surveyed last week by Reuters predicting no change.

Some believe that although rates are likely to fall this year little has changed since the previous MPC meeting in June to justify a change now and the committee will wait until August when it updates its forecasts.

On one hand the estimate of growth in the first-quarter has been revised down to 0.1 per cent - its worst since 1992 - from 0.2 per cent, while retail sales growth hit a four-year low in May.

However, continued growth in house prices, record volumes of mortgage-equity withdrawal by homeowners and upbeat business surveys for June do not point to an economy falling into recession.

A key factor will continue to be the pound's exchange rate, which has risen by 3 per cent since June, after falling 5 per cent since February.

Last week Mervyn King, the new Governor of the Bank, sparked speculation of a rate cut when he said "perhaps the most significant change in the past month has been the rise in the exchange rate".