Sept. 9 (Bloomberg) -- U.K. manufacturing production declined in July to the lowest level in 1 1/2 years as oil rose to a record, dragging on economic growth.

Factory output fell 0.2 percent from June, the Office for National Statistics said today in London, declining for a fifth month. Economists predicted a drop of 0.1 percent, according to the median of 28 forecasts in a Bloomberg News survey. The index of manufacturing was at 103.3, the lowest since February 2007.

Higher energy prices, weaker domestic demand and slowing growth in the euro region, Britain's biggest export market, have hurt manufacturers. The pound has declined 10 percent against the euro this year as investors increase bets that the U.K. will fall into a recession and the Bank of England will cut interest rates.

``Despite the move down in the currency, manufacturing is still subdued,'' said George Johns, an economist at Barclays Capital in London. ``The bank can start to think about rate cuts once we see a peak in inflation.''

The pound was little changed after today's report, staying close to a 2 1/2-year low against the dollar. It traded at $1.7568 as of 9:35 a.m. in London. It was worth 80.44 pence per euro.

Manufacturing accounts for 15 percent of the U.K. economy, compared with about 75 percent for services industries. Ten out of 13 categories of factory production fell on the month, led by electrical and optical equipment, the statistics office said.

Industrial Production

Factory output fell 1.1 percent in the three months through July, the most since November 2005. Industrial production, which includes utilities, mining and oil extraction, also fell by the most in almost three years in the period, the report showed.

McBride Plc, Europe's largest supplier of store-brand household goods to supermarkets, said last week that full-year profit fell 36 percent, hurt by increases in energy-related costs.

Oil prices have fallen 25 percent since reaching a record $147 on July 11. The 40 percent increase in the past year is still keeping U.K. inflation at more than twice the Bank of England's 2 percent target, making it harder for policy makers to lower borrowing costs from the current 5 percent.

Prime Minister Gordon Brown's government yesterday announced that it will spend about 150 million pounds ($265 million) to bolster the U.K. manufacturing industry. The drop in the pound against the euro this year will also help exporters by making goods cheaper overseas.

Still, the economy of the 15 euro-region countries shrank 0.2 percent in the second quarter, the first contraction since the currency was introduced almost a decade ago.

Housing Market

The U.K. is heading for its worst economic performance since the early 1990s after failing to expand in the second quarter. House prices fell in August as the squeeze on credit pushed down sales to a record low, the Royal Institution of Chartered Surveyors said today.

Toyota Motor Corp., the world's second-largest carmaker, last month announced that it will cut production at British factories and it reduced its forecast for sales.

Producer prices unexpectedly dropped by the most in 22 years in August as oil fell and the economy stalled. The Bank of England will have room to lower the benchmark interest rate by a quarter- point to 4.75 percent by the end of the year, according to the median of 52 economists' forecasts in a Bloomberg News Survey from Aug. 29. The next decision is Oct. 9.

To contact the reporter on this story: Brian Swint in London at bswint@bloomberg.net.

Last Updated: September 9, 2008 05:07 EDT