Shrinking manufacturing sector 'deeply worrying'

British manufacturing shrank at its fastest rate for three years in July, highlighting the perilous state of the economy as the Chancellor George Osborne launched his Funding for Lending programme to encourage banks to lend more to businesses and households.

The Markit/Cips PMI manufacturing index dropped unexpectedly sharply from 48.4 in June to 45.5 in July – any measure below 50 indicates the sector is shrinking. This is the first major economic indicator suggesting the third quarter in Britain has got off to an even worse start than the second.

Osman Ismail, an economist with the Centre for Economics and Business Research, said: "These data offer a first glimpse at how manufacturing performance may develop in the third quarter and there remains little to be cheerful about. The manufacturing recessions in both the UK and the eurozone are set to drag on, placing continued downward pressure on economic growth during the second half of the year."

The Institution of Mechanical Engineers said the drop for a third month running was "deeply worrying" and called on the Government to launch a "detailed manufacturing and industrial strategy". The data came as the Government kicked off its £80bn Funding for Lending scheme – its latest attempt to encourage banks to increase loans to homeowners and businesses – against a backdrop of bleak new figures on Britain's manufacturing and housing markets.

The boss of Britain's second-largest housebuilder welcomed the programme. Peter Redfern, Taylor Wimpey's chief executive, said: "This could potentially have a significant effect on the housing market. It does really seem to give the banks an incentive to lend more rather than just bullying and goading them to do so.

"We could really start to see banks competing once again for market share in mortgages."

Ray Boulger, of the mortgage brokers John Charcol, agreed: "The Funding for Lending Scheme is very quickly proving effective as far as the mortgage market is concerned."

The £80bn Funding for Lending scheme allows banks that increase their lending to borrow money from the Bank of England at discounted rates for up to four years.