The economy shrank by 0.5 per cent between July and September, new figures confirmed today, after household spending recorded its biggest fall since 1995 and manufacturing activity slowed.

Official figures show that household spending fell by 0.2 per cent compared to the previous quarter as consumers slash expenditure in the face of the recession.

This is the biggest fall in household spending in more than 13 years, and the first time there has been two consecutive quarters of decline since the recession of the early 1990s.

There are hopes that the recent 1.5 per cent cut in interest rates coupled with the 2.5 percentage point reduction in VAT, announced in the Pre-Budget Report, could encourage consumers to spend more in the coming year, helping to boost the economy.

The country is widely believed to be in recession, with the Bank of England expecting the economy to shrink until the middle of next year.

Economists said that the downturn in the third quarter could have been more severe. Howard Archer, chief UK and European economist at IHS Global Insight, said: "GDP would have contracted even more in the third quarter but for strong Government spending adding 0.2 percentage points."

Manufacturing activity slumped by 1.3 per cent, revised down from a previous estimate of 1 per cent.

The distribution, hotel and catering sector was also hammered, with activity falling by 1.9 per cent - the biggest decline since 1980. Retail and wholesale traders, which are included in this sector, were the worst affected, slumping by 2.4 per cent in the quarter.

Workers' pay rose by a modest 0.4 per cent during the three months, while company profits were up 0.8 per cent, the figures from the Office for National Statistics showed.

The figures are likely to increase pressure on the Bank of England to cut rates again next month.

Mervyn King, Governor of the Bank of England, indicated yesterday that the Monetary Policy Committee would be prepared to cut borrowing costs again as he told the Treasury Select Committee that banks must start lending again.

He said: "We may need to cut bank rate more than we would otherwise have done."

David Page, economist at Investec, said: "Our view on interest rates is unchanged on the back of this. We still see a 0.5 per cent cut coming through in December."

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