Dive in business investment raises fears for recovery

Capital spending crashes at fastest rate since records began in 1966

Business investments crashed at a record-breaking rate in the second quarter, adding to fears that recovery from recession will be weak and protracted.

Investment fell 10.4 per cent compared with the previous three months, its fastest rate for nearly 25 years, and by 18.4 per cent compared with the previous year, the biggest fall since records began in 1966, according to the Office of National Statistics.

The declines were spread across nearly all industries. Worst-hit was the private sector manufacturing sector, where capital spending was down by 16.8 per cent overall, thanks to a 21 per cent drop in the food, drink and tobacco business, 24 per cent in engineering and vehicles and 25 per cent in textiles, clothing and footwear.

In the non-manufacturing sector, investment by services companies was down 11.4 per cent and by construction groups by 9.1 per cent. The only categories where investment rose were health and social work.

The sharp falls appear to contradict the tentative green shoots elsewhere in the economy. Recent numbers on consumer spending and the housing market both show slight improvements: retail sales in July came in up 3.6 per cent year on year, and Nationwide reported yesterday that house prices rose for the fourth consecutive month, the fastest rate for two and a half years.

Jonathan Loynes, chief European economist at Capital Economics, said: "The fact that this is the second big drop in business investment in a row is a concern, so whilst some areas of economic activity are showing signs of stabilising, other areas continue to fall very sharply."

To some extent the mismatch can be explained as part of a typical recessionary pattern. There is often a lag between a downturn in economic activity and a fall in business investment. Capital spending is often funded at least partly out of profits, so it often suffers last.

Business investment also has only a fraction of the impact on the economy compared with ups and downs in consumer activity. Household spending accounts for around two-thirds of GDP, compared with just 10 per cent from business investment.

But investment by companies has a longer-term implication. Mr Loynes said: "Capital spending by companies has a twin effect – there is the arithmetic impact on the level of GDP as the investment takes place, but also the impact on the economy's ability to produce and operate in the future."

And although the economy can theoretically still pick up while business investment remains low, the specifics of the current recession give less cause for optimism. Not only is household spending expected to remain muted for some time in the aftermath of the credit crunch, but government is also facing lean times.

"The latest investment figures raise serious doubts about the hopes that companies will compensate for sluggish activity amongst householders and government," Mr Loynes said. "This is going to be a drawn-out downturn and recovery will be gradual."