Growth slowdown prompts hopes of interest rate cut

By Gary Duncan, Economics Editor

GROWTH in the economy slowed to its weakest rate in more than two years in the first quarter as consumer spending virtually stalled, stoking expectations that interest rates will be cut in the summer. With overhauled official figures also showing that the economy was weaker than previously reported in each of the past four quarters, some economists were left betting that the Bank of England could even cut base rates next week.

In a blow to Gordon Brown’s hopes for another year of buoyant economic expansion, yesterday’s revised national accounts cut quarterly growth in the first three months of the year (Q1) to just 0.4 per cent — down by a third from an initial estimate of 0.6 per cent.

The slowdown came as manufacturing shrank more severely than first thought, by 0.9 per cent, and services expanded a little less robustly, by 0.7 per cent.

The economy’s annual growth rate for the year to Q1 was also revised sharply lower, from 2.7 per cent to only 2.1 per cent, the worst such performance since the end of 2002.

City analysts said that the downgraded GDP data blew a hole in the Chancellor’s forecasts for annual growth over 2005 of 3 per cent to 3.5 per cent.

With fading growth also likely to undermine tax revenues, economists sounded warnings that Mr Brown is now likely to breach his borrowing forecasts, raising the threat of tax rises.

An abrupt slowdown in consumer activity was a driving force behind the economy’s lacklustre first quarter, as household spending all but ground to a halt, rising at a quarterly pace of just 0.1 per cent — the smallest gain in more than four years.

A 1.7 per cent drop in company profits in Q1, with financial groups’ earnings down 11.4 per cent, emphasised the apparent fragility of the economy.

The weakness of consumer spending came even after a rise in households’ real disposable incomes in Q1, which recovered from a small decline in the final quarter of last year to climb 1.2 per cent, the strongest rise for almost two years.

Despite higher incomes, the national accounts figures suggested that households opted to start rebuilding savings rather than carry on their past high-spending habits. After tumbling to a record low of 4.2 per cent in 2004, the savings ratio, a gauge of savings activity, recovered a little to a still low 4.8 per cent in the last quarter.

Anxiety that consumers could continue to cut back spending in order to boost savings, further hitting growth, was stoked by the latest fall in house prices and a parallel drop in consumer sentiment.

Worries over economic prospects sent GfK’s barometer of consumer confidence tumbling this month, with its headline index dropping to minus 3, from May’s minus 1.

Both sentiment and spending could be further undercut by the latest bad news from the property market, after Nationwide building society said house prices dropped 0.2 per cent this month. The fall cut the annual rate of house price inflation to a nine-year low of 4.1 per cent.

The spate of bleak figures left analysts arguing that base rates are likely to fall in July or August. Most economists believe the Bank is likely to take the three quarters in a row of growth below the economy’s long-term trend now shown by the national accounts as a cut for action.

Hawks on the Bank’s Monetary Policy Committee may seize on upward revisions to growth over the past three years, to argue that less slack in the economy could fuel inflationary pressures.