UK economic recovery comes to surprise halt in Q4

[January 25, 2011]  LONDON (AP) -- Britain's economy contracted by half a percent in the last three months of 2010, official data showed Tuesday, shocking markets which had expected a continued recovery and causing the pound to slump.

Severe winter weather in December had a strong impact, particularly on the construction sector, the Office for National Statistics said. Not counting the effect of the snow, which snarled transport and kept people away from shops before Christmas, it estimated GDP would have been flat -- still well below market expectations for at least 0.4 percent growth.

Analysts warned that the underlying performance of the British economy had taken a severe hit, casting doubt over the government's plans for sharp spending cuts and tax hikes.

"We are in for a rough ride," said Graeme Leach, chief economist of the Institute of Directors, a membership organization of business leaders. Expectations of 1.3 percent growth in 2011 would have to be downgraded, he said, and pressure would grow on the Bank of England to resume pumping money into the economy.

The pound fell sharply from $1.5901 to a low of $1.5753 immediately after the figures were announced.

The dismal figures muted any expectation that the Bank of England would soon raise its base interest rate from an all-time low of 0.5 percent to deal with persistent high inflation. Its pump-priming program of asset purchases, known as quantitative easing, was suspended in December 2009 after injecting 200 billion pounds ($320 billion) into the economy.

"However worried the Bank of England may be about its credibility, raising interest rates against a backdrop of such weak demand seems out of the question," said Simon Hayes at Barclays Capital.

"At the same time, with tax rises in the first half of 2011 already expected to hit consumer demand, the government is open to accusations of causing a double-dip recession. Plan B may need dusting off."

Britain's Treasury chief, George Osborne, said the government "will not be blown off course by bad weather."

"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," Osborne said.

But analysts noted that the weak figure was not due only to the poor weather.

Output of the dominant services sector dropped by 0.5 percent and construction slumped by 3.3 percent, the ONS said. Manufacturing and other production industries were a bright spot, with 0.9 percent growth.

The figures are preliminary, leaving them open to revision, and followed four quarters of growth -- including 0.7 percent in the third quarter -- as Britain climbed out of a deep recession.

Jonathan Loynes, chief European economist at Capital Economics, said the figure was "shockingly bad" and would "raise serious concerns over whether the economy is in a strong enough position to withstand the coming fiscal tightening."

Analysts generally expect growth to slow in 2011 due to the impact of government job cuts and a hike in the broad-based sales tax -- the value-added tax -- from 17.5 percent to 20 percent.

"Presumably GDP growth will now rebound pretty strongly in Q1, as it did after weather effects in Q4 2009. But other adverse forces, not least the impact of the latest VAT hike, could limit the size of the bounce," Loynes said.

Although British exporters could benefit from strong demand from booming economies in Germany, China and the Middle East, the risks of a return to recession have increased, according to Chris Williamson, chief economist for Markit.

A day earlier, a senior business leader accused Prime Minister David Cameron's government of neglecting growth while it hacked at spending.

"It's not enough just to slam on the spending brakes. Measures that cut spending but killed demand would actually make matters worse," said Sir Richard Lambert, outgoing director-general of the Confederation of British Industry.

Lambert said business growth was impeded by some government policies, including a cap on immigration, a shakeup of planning regulations, and the planned abolition of employers' rights to force workers to retire at 65 regardless of their performance.

[Associated Press; By ROBERT BARR]

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