Activity in the construction sector slumped to a record low during July as conditions in the housing market continued to deteriorate, raising fears that Britain is edging closer to a recession.

According to the Construction Managers' Index, which measures trends in the housing, commercial and civil engineering sectors, activity in the industry fell for the fifth month in a row to a reading of 36.7 — the lowest figure since the series began in 1997.

The index first fell below 50, which indicates that the sector is contracting, rather than growing, in March.

The residential housing sector was the worst affected with the index of activity in this area falling for the eight month to a new low of 18.7 in July, down from 25.6 in June.

The commercial property sector also contined to decline, falling from 41.1 in June to 38.2 in July.

Only civil engineering showed any growth, rising to 46.5, up from 40.

However, the general outlook for the coming months is set to worsen further, with new orders falling from 43.5 in June to a reading of 41.

The construction sector shrank by 0.7 per cent in the second quarter of the year, according to official data released two weeks ago, and these figures suggest that the sector could fall even more sharply during the rest of the year.

Construction accounts for about 6 per cent of the economy, but analyts said that, despite its modest size, the rapid deterioration in the sector does not bode well for the economy, particularly following poor manufacturing figures last week.

Howard Archer, chief UK and European economist at Global Insight: "There can be little doubt that the construction sector is now firmly in recession.

"This reinforces our belief that the overall economy is more likely than not to contract in the second half of 2008."

Economists forecast that figures out tomorrow inidicating the health of services companies, which range from banks to cafes and make the biggest contribution of 74.4 per cent to the UK economy, will also show that activity is slowing rapidly.

Widescale job cuts in the housing sector were reflected in today's figures, with the employment index falling to 45.6 in July, down from 47.8 the previous month.

Construction companies have been among the hardest hit by the rising cost of materials and the seizure in the mortgage market.

The figures were released just three days before the Bank of England's Monetary Policy Committee (MPC) is due to announce its decision on interest rates.

The current cost of borrowing is 5 per cent, and the MPC is widely expected to keep rates unchanged.

However, a few commentators have suggested that the MPC may move to stem rising inflation, currently at 3.8 per cent and well above the Government's 2 per cent target, by announcing a quarter-point rise to 5.25 per cent.

Household budgets remain under pressure and last week, Centrica, which owns British Gas, shocked the country by announcing a 35 per cent rise to gas bills, following double-digit price rises by EDF.

The battle to control inflation is also being played out in continental Europe where soaring energy costs forced producer prices to rise at a record rate in June.

It is a blow to the European Central Bank (ECB), which is also due to make its monthly interest rate decision this week.

Prices at factory gates in the 15 countries in the eurozone rose by 0.9 per cent in June, pushing the annual increase to 8 per cent, said Eurostat, the European Union statistics office.

It is the highest annual increase since the series began in 1991.

Mr Archer said that this gloomy news could force the ECB to increase rates to 4.5 per cent. "Clearly, a further interest rate hike is a real possibility and the ECB is very likely to keep talking tough on inflation following this Thursday's policy meeting."

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