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REFILE-UPDATE 2-Britain sinks far deeper into recession than forecast

by on July 25, 2012 12:23 pm BST
 

Wed Jul 25, 2012 8:23am EDT

* UK GDP falls 0.7 pct in Q2, biggest drop since Q1 2009

* Osborne warns of “deep-rooted economic problems”

* Opposition urges more action to boost growth

By David Milliken and Olesya Dmitracova

LONDON, July 25 (Reuters) – Britain’s economy shrank far
more than expected in the second quarter, battered by everything
from an extra public holiday to government spending cuts and the
neighbouring euro zone crisis.

Finance minister George Osborne said figures released on
Wednesday showed Britain had “deep-rooted economic problems”,
adding that the slump in the second quarter was disappointing
even when taking into account one-off factors that hurt.

Britain’s gross domestic product fell 0.7 percent compared
with the first three months, the sharpest fall since the height
of the global financial crisis in early 2009, the Office for
National Statistics said, showing a bigger drop than any of the
economists surveyed in a Reuters poll last week had expected.

Output in Britain’s service sector — which makes up more
than three quarters of GDP — contracted by 0.1 percent in the
second quarter after growing 0.2 percent in Q1 2012.

Industrial output was 1.3 percent lower, while construction
— which accounts for less than 8 percent of GDP — shrank by
5.2 percent, its biggest drop since the first quarter of 2009.

The figures confirmed that Britain remains mired in its
second recession since the start of the financial crisis, with
the economy shrinking for a third consecutive quarter.

The broad-based slump will fuel pressure on the government
to get the economy growing again after a crisis that has left
many Britons poorer with rising prices and higher taxes eating
up meagre wage increases.

However, Osborne believes he has no money left for a
meaningful spending boost, having staked his reputation on a
tough plan to eliminate a budget deficit, still around 8 percent
of GDP. The lack of growth also puts this goal into question.

Sterling hit its lowest in nearly two weeks against the
dollar after the data, and two-year government bond yields hit a
record low on speculation that the Bank of England may have to
provide more economic stimulus than expected.

The central bank has already embarked on another 50 billion
pound programme of gilt purchases with newly created money to
soften a grim economic outlook, but the dismal numbers boosted
speculation that it may cut interest rates later this year.

“This is terrible data. Frankly there’s nothing good that
comes out of these numbers at all,” said Peter Dixon, an
economist at Commerzbank.

“The economy looks to be badly holed below the water line at
this stage. It’s a far worse period of activity than we’d
expected,” he said.

OLYMPIC REBOUND

Britain is due some kind of boost over the coming months as
production looks set to rebound from the hit from the extra
public holiday to celebrate Queen Elizabeth’s Diamond Jubilee in
June, and from the ticket sales and visitors’ spending during
the London Olympics that it is hoped will boost growth.

But the overall outlook remains poor.

Many Britons have reined in spending since the crisis and
business are holding back investment as the lack of demand and
fears about the spillovers from the euro zone crisis weigh on
confidence, with the lack of credit hurting smaller firms.

“There are a great many so-called ‘zombie businesses’
teetering on the edge and operating on fine margins, and many
directors are becoming increasingly weary after several years of
tough trading,” said Julie Palmer of business recovery and
restructuring specialist, Begbies.

But business surveys have so far painted a less dire picture
of the economy, and unemployment has been falling over the past
few months, leading some economists to voice doubts about the
official data.

The Confederation of British Industry’s monthly survey
showed that manufacturers’ order inflow unexpectedly improved in
July, though their quarterly survey showed dwindling confidence
among firms about their outlook.

The CBI’s director-general, John Cridland, said businesses
were not reporting a sharp contraction in outlook.

“The overwhelming view is that right now the economy is flat
rather than negative, and there is potential for Britain to get
back into growth later in the year,” he said.

The ONS said it was too early to provide an estimate of the
Jubilee effect, but warned that this and the wettest spring on
record added “uncertainty”, increasing the scope for revisions.

Before the data, economists had pencilled in a 0.4-0.5
percent hit, meaning that at least some of the fall in second
quarter output represents an underlying contraction.

AUSTERITY

The weak economy remains the biggest headache for the
government and the opposition Labour party seized on the latest
slump to reiterate its call for a change in policy.

“We need some action from the chancellor (finance minister),
not excuses … and digging a deeper hole for the country,”
Labour finance spokesman Ed Balls said in a BBC interview.

Last week the International Monetary Fund slashed its growth
forecast for Britain by more than those for any other advanced
economy, and warned the government and BoE that they will need
to rethink their approach if the economy fails to pick up by
early next year.

Eliminating Britain’s structural budget deficit over the
next five years is the central political goal of Britain’s
coalition of Conservatives and Liberal Democrats, but the
opposition Labour Party says the pace is too rapid.

Over the past month the coalition and BoE have announced
several measures to ease the flow of credit to households and
businesses, as the euro zone debt crisis saps demand in
Britain’s major export markets.

But for now, any change to the fiscal austerity programme is
opposed both by finance minister Osborne and BoE Governor Mervyn
King, who fear it could trigger a loss of confidence in
Britain’s commitment to long-term deficit reduction.