UPDATE 2-Shock industrial output fall raises UK recovery fears

Fri Mar 9, 2012 9:13am EST

* Data raises worries UK economic contraction may continue

* Biggest annual fall in industrial output since Nov 2009

* Largest monthly jump in factory gate prices since April

* Construction output slumped in January and December

By David Milliken and Fiona Shaikh

LONDON, March 9 (Reuters) - British industrial and construction output suffered a shock fall in January, raising the risk the economy will slide back into recession at a time that rising oil prices are posing a dilemma for policymakers.

Friday's data from the Office for National Statistics will put extra pressure on finance minister George Osborne to find measures to boost growth as he prepares to unveil his 2012 budget on March 21, and may raise the chances that the Bank of England will extend its asset purchase programme in May.

Industrial output shrank by 0.4 percent in January, wiping out December's gains and confounding economists' forecasts for a 0.3 percent rise. None of the economists polled by Reuters had expected a fall this month after a string of upbeat private-sector surveys, and the annual decline of 3.8 percent was the biggest in more than two years.

"Today's disappointing industrial figures ... suggest that the manufacturing recovery is already starting to lose steam," said Capital Economics's Samuel Tombs.

Other data this week showed Italian industrial output fell 2.5 percent in January, while France and Germany reported growth of 0.2 percent and 1.6 percent respectively - reflecting the contrasting fortunes of the euro zone's three biggest economies.

The fall in British production was driven by a slump in oil and gas output. The energy sector was a persistently weak in 2011 due to unplanned maintenance, unfavourable weather and a long-term decline in Britain's North Sea energy reserves.

But factory output, which accounts for the lion's share of industrial production, was also weaker than expected, growing by just 0.1 percent compared to forecasts of 0.3 percent.

This was a particular surprise given relatively strong recent surveys from purchasing managers' and industry bodies.

Overnight, Britain's main manufacturers' association, EEF, had said factory output rebounded at the start of 2012 and that firms expected output and orders to grow at their fastest pace in a year over the next three months.

Further bad news came from the construction sector. Non-seasonally adjusted output fell 12.3 percent in January after an 11.8 percent decline in December, according to the ONS, despite relatively good weather over the period.

Even by the standards of what is a volatile series, this was a sharp fall that would make it hard for the economy as a whole to show growth after its 0.2 percent contraction in the fourth quarter, said RBS economist Richard Barwell.

"The prospect of a technical recession looked pretty distant until today. Not anymore."

OIL PRICE PROBLEM

Rising oil prices complicate the picture for policymakers. The BoE's ability to pump further stimulus into the economy on top of the 50 billion pounds of quantitative easing approved last month hinges on its confidence that inflation will fall back to its 2 percent target in the medium term.

Consumer price inflation is currently 3.6 percent, and is forecast to fall below target by the end of the year. But past forecasts have been thrown off track by spikes in oil prices, and in February factory gate inflation edged up to 4.1 percent - its first increase since CPI hit a three-year high in September.

Producer prices were pushed up by sharp monthly increases in firms' input costs for crude oil and domestically-produced food, the latter rising by the biggest margin since April.

"Sticky inflation would maintain the squeeze on consumers' purchasing power and make it harder for the Bank of England to do more quantitative easing should the economy continue to struggle," said IHS Global Insight economist Howard Archer.

Bellwether retailer John Lewis reported a 4.4 percent rise in weekly sales earlier on Friday, and a Lloyds survey showed consumer sentiment at a six-month high.

Higher oil and food costs are a double-edged sword for inflation, in the view of many BoE policymakers. Although they push up prices in the short-term, in the long run they dampen consumer demand and may pull down inflation if broader expectations remain stable.

The latest BoE survey of public inflation attitudes, also published on Friday, suggests these remain in check for now, with forecasts for the year ahead sinking to an 18-month low of 3.5 percent.

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