U.K. Services Contract, Factory Production Drops

By Jennifer Ryan and Svenja O'Donnell
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Aug. 5 (Bloomberg) -- U.K. services from banks to airlines contracted in July and factory production unexpectedly dropped for a fourth month in June, evidence the economy may be shrinking.

An index based on a survey of about 700 service companies was at 47.4, staying below the 50 threshold for expansion for a third month, the Chartered Institute of Purchasing and Supply said today. Factory production dropped 0.5 percent, the Office for National Statistics said.

The pound fell against the dollar after the reports, which showed that the credit squeeze, falling house prices and record oil costs have choked economic growth. The Bank of England probably won't cut the benchmark interest rate from the current 5 percent this week to avert a recession as policy makers battle to control the fastest inflation in 11 years, economists say.

``The Bank of England's hands are tied,'' said Nick Kounis, an economist at Fortis in Amsterdam and a former U.K. Treasury official. ``We're forecasting a recession in the second half. The odds are significantly above 50 percent.''

The pound fell to its lowest level in seven weeks against the dollar, and traded at $1.9552 as of 11:59 a.m. in London.

GKN Plc, the U.K. car-parts company that also builds plane components, today said first-half profit fell 3 percent as raw- material prices rose. British Airways Plc said Aug. 1 that first- quarter profit fell 90 percent and the airline cut its revenue forecast on record fuel costs and reduced demand.

Bank Losses

HSBC Holdings Plc, based in London and Europe's biggest bank by market value, said yesterday that first-half profit declined 29 percent as it set aside more money for bad loans in the U.S. Banks worldwide have announced more than $482 billion in losses and writedowns from the collapse of the U.S. subprime mortgage market.

``We are going through a tough time that is likely to continue for a while,'' Chancellor of the Exchequer Alistair Darling said in an interview on BBC Radio 4 today. ``It isn't just the effects of the credit crunch but it's also the effects we are seeing in very high oil prices.''

Today's services report excludes retailers, which along with other parts of the industry make up three-quarters of the economy. The CIPS reports for July showed manufacturing, about 15 percent of gross domestic product, shrank the most in a decade, while construction contracted the most since 1997.

Twelve out of 13 categories of factory production fell in June, led by a decline in electrical and optical equipment, the statistics office said. Economists had predicted a 0.1 increase on the month, according to the median of 30 forecasts in a Bloomberg News survey.

Oil Costs

Record commodity prices are also crimping companies' margins. Oil rose above $147 a barrel for the first time last month, while corn and wheat prices climbed to the highest ever this year.

The U.K. economy expanded 0.2 percent in the second quarter, matching the slowest pace since 2001 and sharpening the central bank's dilemma on interest rates. Inflation accelerated to 3.8 percent in June, the highest in more than a decade and almost double the bank's 2 percent target.

The bank will publish its next quarterly inflation and growth forecasts on Aug. 13. All 60 economists in a Bloomberg News survey predict the Monetary Policy Committee will keep the main rate unchanged for a fourth month this week. The bank will announce the decision at noon in London on Aug. 7.

``I would certainly be voting for cuts if I were on the MPC,'' said James Shugg, an economist at Westpac Banking Corp. in London. ``The situation on the economy is so dire, ultimately they'll see there's a massive risk of an inflation undershoot.''

To contact the reporter on this story: Jennifer Ryan in London at Jryan13@bloomberg.net; Svenja O'Donnell in London at sodonnell@bloomberg.net.