UPDATE 1-Weak August UK factory output dents recovery hopes

(Adds market reaction, economist comment)

By David Milliken and Sven Egenter

LONDON, Oct 9 (Reuters) - British factory output dropped inAugust and the country's trade deficit widened sharply, datashowed on Tuesday, dampening prospects for a sustained recoveryin the second half of 2012.

Manufacturing output dropped 1.1 percent in August after adownwardly revised bounce of 3.1 percent in July, the Office forNational Statistics said. Economists had forecast a dip of 0.6percent on the month.

Britain's goods trade deficit widened more than expected to9.8 billion pounds, as exports fell and oil imports rose, andits total trade deficit - which includes buoyant servicesexports - rose to its second highest on record.

"Certainly it looks like the manufacturing sector isstruggling and being affected by the very weak euro area economyand weak global backdrop," said Investec economist VictoriaClarke.

Sterling fell to a fresh one-month low against the dollar onTuesday while UK share prices also declined.

Britain's economy has probably emerged from recession in thethird quarter, but a vigorous return to health still lookselusive, keeping the pressure on the government and the centralbank to boost growth.

The International Monetary Fund (IMF) slashed its forecastsfor Britain's economy, predicting a contraction of 0.4 percentfor this year and meagre growth for 2013.


The country has not recovered the output lost during the2008-2009 slump, and fell back into recession late last year.

Most economists think Britain achieved some growth in thethird quarter as production bounced back from the effect of anextra public holiday in June, and ticket sales for the LondonOlympics and Paralympics added to gross domestic product.

Industrial output, which includes energy production andmining, fell 0.5 percent on the month in August, in line withexpectations, after a 2.8 percent rise in July.

In more positive sign for the wider economy, retailersposted a solid rise in sales last month as Britons splashed outon sturdy shoes and warm clothes, and another survey showed thathouse prices fell at a slower rate.

But recent business surveys have shown a renewed weakeningin sentiment, increasing concerns of an economic relapse asgovernment spending cuts continue to hurt growth, and the eurozone debt crisis is hitting exports and business morale.

A sharp worsening in Britain's net exports had been one ofthe main drags on the economy in the second quarter, when outputshrank by 0.4 percent.

With the government's hands tied by its pledge to erase thecountry's huge budget deficit over the coming five years, theonus is on the Bank of England to stimulate the economy.

Finance minister George Osborne vowed on Monday not to waverfrom his austerity plans, although the IMF said on Tuesday thathe may need to defer some spending cuts planned for next year ifthe economy is much weaker than forecast. The IMF also said theBoE may need to loosen policy further.

Most economists expect the central bank to extend itsquantitative easing purchases of government bonds once thecurrent 50 billion pound round is completed in November.

(Additional reporting by Olesya Dmitracova and Li-mei Hoang.Editing by Jeremy Gaunt.)


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