Britain sinks deeper into recession

London - Britain’s economy shrank far more than expected in the second quarter of 2012, battered by everything from an extra day’s holiday to budget austerity and the neighbouring eurozone crisis.

Finance minister George Osborne said the country had “deep-rooted economic problems”.

The Office for National Statistics said Britain’s gross domestic product (GDP) fell 0.7% in the second quarter, the sharpest fall since early 2009 and a bigger drop than any of the economists surveyed in a Reuters poll last week had expected.

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

It will add pressure on Osborne to get the economy growing again after a crisis that has left many Britons poorer as rising prices and higher taxes ate up meagre wage increases.

Sterling hit its lowest in nearly two weeks against the dollar after the data, and government bond prices rallied on speculation that the Bank of England (BoE) may have to provide more economic stimulus than expected.

Earlier this month the BoE has announced another £50bn programme of gilt purchases with newly created money to soften a grim economic outlook, but Wednesday’s data is likely to add to market 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.”

Headwinds

Economists had been expecting an extra public holiday to mark Queen Elizabeth’s diamond jubilee to reduce output by around 0.5%, so the latest figures suggest the economy is also contracting on an underlying basis.

The ONS said it was too early to provide an estimate of the jubilee effect, but warned that this and very wet weather added “uncertainty” to its calculation of economic activity towards the end of the quarter.

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

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

Overall second-quarter GDP was 0.8% lower than a year earlier, the biggest decline since the last three months of 2009.   

Before Wednesday’s data, most economists expected a return to growth in the third quarter, as the London Olympics offer a one-off boost through ticket sales and visitors spending.

And some argue that increasing employment levels suggest the economy is healthier than the headline GDP figures suggest.

But the overall outlook is poor.

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.

Austerity

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 eurozone 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 George Osborne and BoE governor Mervyn King, who fear it could trigger a loss of confidence in Britain’s commitment to long-term deficit reduction.

“We're dealing with our debts at home and the debt crisis abroad. We’ve made progress over the last two years in cutting the deficit by 25% and businesses have created over 800 000 new jobs,” Osborne said in a statement.

“But given what’s happening in the world we need a relentless focus on the economy and recent announcements on infrastructure and lending show that’s exactly what we’re doing.”