Fears of a recession were heightened yesterday as manufacturing activity fell in July for the third month in a row, and at the fastest pace in nearly a decade.

In a sharper drop than analysts had forecast, the headline index of manufacturing activity from the Chartered Institute of Purchasing and Supply fell to 44.3 in July, down from 45.9 in June.

This is the lowest reading since December 1998. Any figure under 50 suggests that the sector is shrinking, and analysts said that the decrease in the index for new orders, which fell to 40.5 from 43.7, indicated worse to come.

Hetal Mehta, economic adviser to Ernst & Young's ITEM club, said: “This, combined with a weak GDP figure for the second quarter, raises the possibility that the economy as a whole could see a contraction in the third quarter of the year.”

The economy grew by a modest 0.2 per cent in the second quarter of the year. The balance of output prices also edged up to a record high of 63.1, from 62.6.

However, Vicky Redwood, at Capital Economics, the economic consultancy, said that the rise in output prices was not as steep as the rise in input prices over previous months, an indication that firms were accepting “at least some squeeze on their margins”.

But the rise in output prices will still trouble the Bank of England's rate-setting committee next week as it grapples with soaring inflation while the economy grinds to a halt.

To add to the Bank's worries, there are signs that job losses in the manufacturing sector are set to accelerate.

The employment index fell to 43.3 in July, down from 46.2 in June, the sharpest drop since December 2001.

Job losses have been recorded in each of the past four months. The CBI said last month that the manufacturing sector could lose 36,000 jobs over the rest of the year.

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