Manufacturing closed 2011 with its worst quarter in more than two years despite signs that factories propped up output in December by eating into backlogs, data showed, leaving the economy on course for another recession.
The Markit/CIPS Manufacturing Purchasing Managers' Index (PMI) rose to 49.6 in December from an upwardly revised 47.7 in November, data compiler Markit said.
The latest reading was below the 50 mark that signals growth in activity but well ahead of forecasts in a Reuters poll for a fall to 47.4 and featuring a rare and welcome rise in export orders.
But other surveys showed on Tuesday that companies are bracing for a slump, and most economists see the central bank responding with additional asset purchases to limit the downturn.
The improvement in the PMI is welcome, said Investec economist Philip Shaw.
Nonetheless, it seems to be due to firms eating into backlogs of work to keep output up, in which case the sector remains vulnerable to a sharper downturn over the coming months, he added. Our central view is that the economy as a whole will experience a short recession.
Markit economist Rob Dobson said that over the fourth quarter as a whole the PMI reading suggested the sector registered its worst performance since the second quarter of 2009, when Britain was mired in recession.
Manufacturing will therefore likely be a drag on the Q4 GDP figures, he said.
Manufacturers are also leaning heavily on backlogs of work to prop up production. This is only a temporary fix, and the trend in overall order books needs to improve if the sector is to avoid a protracted period of lacklustre performance.
Sterling rose to a session high and gilt futures extended losses in the wake of the data, though the survey offered no underlying reasons for changing the overall dire outlook for the economy.
BRACING FOR RECESSION
A Reuters poll last month saw an even chance of another recession in Britain in 2012.
Other business surveys published on Tuesday underscored the gloomy mood among Britain's companies. A poll by consultancy Deloitte showed that company CFOs expected the economy to fall back into recession and stay weak for a prolonged period.
Business confidence fell to a three-year low in a Lloyds Bank survey, indicating a 3-in-4 chance of recession.
The Bank of England sees the economy stagnating until the middle of this year, and some policymakers have warned it may shrink in one or two quarters as the euro crisis continues to weigh on morale and cash-strapped consumers cut back on spending.
Bank started injecting an additional 75 billion pounds into the economy in October and economists expect an increase in its asset purchases in February to shore up activity.
A sharp drop in British industrial production and services output in October raised the prospect of a contraction in the final three months of this year.
We estimate that GDP is likely to have contracted by around 0.2 percent and expect the economy to fall into technical recession in the first quarter of this year, said Ernst & Young ITEM Club economist Andrew Goodwin.
The debt crisis in the euro zone, Britain's biggest trading partner, is hurting demand for the country's exports while the government's austerity measures in response to debt problems are hitting consumers.
The British PMI survey showed that export orders posted their first monthly rise since July, with the index rising to the highest level since April, helped by stronger demand for goods from China, Germany and eastern Europe.
However, overall orders still fell, albeit at a much slower pace than in the previous two months. Output was largely stable as companies cleared order backlogs.
Weak demand and competition pressures limited companies' ability to raise prices in December, Markit said.
The output price index dropped to 50.8, the lowest level since October 2009, as input costs fell at the fastest pace since June that year. The figure lends support to the Bank of England's forecast that inflation will drop sharply in 2012.
(Additional reporting by Olesya Dmitracova and David Milliken; Editing by John Stonestreet)