British recession deepens as euro zone woes mount - Reuters

By Fiona Shaikh and Olesya Dmitracova

LONDON | Thu May 24, 2012 9:04am EDT

LONDON (Reuters) - A slump in construction output drove Britain even deeper into recession than initially thought in the first quarter of this year, raising the chance the Bank of England will inject more cash to prop up the faltering economy.

More is also expected to be needed to protect the economy from the worsening euro zone crisis.

Britain is in its second recession since the 2007-2008 financial crisis, and the prospects for a recovery are cloudy as leaders in the euro zone, Britain's biggest trading partner, have made little progress in resolving their debt woes.

The BoE's Monetary Policy Committee (MPC) has indicated it is ready to pump more money into the economy, having paused its asset-buying quantitative easing program at 325 billion pounds this month, amid growing worries about a break-up of the currency union.

"The economy is not recovering properly and with the uncertainty over Europe hanging over the outlook as well, our suspicion is the MPC will sanction further QE at some point later on this year," said Philip Shaw, economist at Investec.

Britain's economy contracted by 0.3 percent between January and March, according to the Office for National Statistics, confounding forecasts for an unchanged reading of -0.2 percent. On the year, GDP shrank by 0.1 percent, the first annual decline since Q4 2009.

The figures will make uncomfortable reading for British finance minister George Osborne, who has vowed to press ahead with harsh austerity measures to curb Britain's debts, despite mounting criticism that spending cuts will stymie a recovery.

Britain's economy has expanded by just 0.3 percent since the Conservative/Liberal Democrat government came to power in 2010, and Thursday's figures showed government spending made the biggest positive contribution to the economy, but it is a prop that will soon fall away.

Faced with growing calls to find ways to boost growth, Britain's finance ministry is looking for measures to channel cash into infrastructure projects and credit-starved companies, but the government warned on Thursday the recovery will be slow.

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The International Monetary Fund this week warned about the risks facing Britain and urged policymakers to boost growth by whatever means necessary.

It suggested the BoE could cut rates further from their record-low 0.5 percent and start buying private-sector assets.

BoE policymaker David Miles rejected that call on Thursday, saying he felt buying gilts was still an effective way to boost the economy and did not feel the BoE had any skill at buying private-sector assets.

"I think it's wrong to think that quantitative easing ... somehow isn't addressing these credit issues," Miles said.

The IMF also recommended that the government should find money to invest in infrastructure and do more to boost the flow of credit to companies.

That would give a much needed boost to the flagging construction sector, which was the main driver behind the downward revision to first-quarter GDP, with a 4.8 percent drop in output - the steepest in three years.

But new data on expenditure was also bleak, and suggested Britain's Q1 downturn would have been even deeper were it not for a 1.6 percent rise in government spending - the biggest rise in four years, and the main positive contributor to GDP.

Household spending, meanwhile, slowed sharply to just 0.1 percent on the quarter, denting hopes for a consumer-led recovery. Separate mortgage lending data on Thursday indicated the housing market remains weak, underscoring the fragile outlook for a consumer rebound.

Exports also suffered: the trade deficit rose to 4.4 billion pounds, and net trade shaved off 0.1 percentage point from GDP.

"The composition of expenditure looks worrying: household consumption was weak with government consumption the main driver of domestic demand. Government spending is unlikely to be a sustainable driver of growth," said Simon Wells, economist at HSBC.

There was one bright spot in Thursday's data: business investment posted its biggest quarterly rise in almost a year, and its largest annual increase in almost seven years.

Analysts cautioned that the outlook remained gloomy, with recent purchasing managers surveys indicating that business activity is tailing off, while an extra public holiday in June is also likely to depress growth in the second quarter.

"With the euro-zone crisis deepening and the knock-on effects already being felt in the UK, we continue to doubt that the recovery will get back on track in the near-term," said Capital Economics analyst Vicky Redwood.

(Additional reporting by Michelle Martin and David Milliken. Editing by Jeremy Gaunt.)