City bets on rate cut as UK grinds to a halt

The City last night shortened its odds on a cut in interest rates next month after government figures showed the British economy slowing to a virtual standstill in the first three months of the year.

With both consumer and business confidence bruised by the build-up to the war in Iraq, the office for national statistics said growth eased from 0.4% in the final three months of 2002 to just 0.2% in the first quarter of 2003.

Britain's weakness was mirrored on the other side of the Atlantic, where figures for American GDP released yesterday revealed that the world's biggest economy was growing at an annual rate of 1.6% in the first quarter.

City analysts said the quarterly data cast doubts on Gordon Brown's forecast that the economy could expand by 2.5% this year, and would put pressure on the Bank of England's monetary policy committee to reduce borrowing costs from their 48-year-low of 3.75% at its meeting next month.

Minutes of the April MPC meeting indicated only two of the nine members voted for lower rates, but analysts believe the GDP figures may have an impact on voting in May.

Geoffrey Dicks, chief economist with RBS financial markets, said: "The data were on the weak side of our and the market forecast. Overall it was almost certainly slower than the MPC was assuming in its February forecast and maybe enough to swing more of them behind a rate cut in May."

The Bank's last inflation report in February predicted that the economy would grow in line with its long-term trend of 2.5% in 2003, but economists said yesterday following the sluggish start to the year, it would take growth of 0.9% in each of the remaining quarters to reach that figure.

Robust growth in the middle of 2002 means GDP in the first quarter was 2.3% up on a year earlier, but economists said to achieve 2% growth this year - the bottom end of the chancellor's forecasting range - would require quarterly growth rates from now of 0.5%.

Alan Castle, economist with Lehman Brothers, said: "It does look like a very weak near-term GDP profile. Compared with what the Bank of England was expecting in February, it's much weaker."

A breakdown of the data from the ONS showed the service sector has ceased to be the engine of growth for the economy, expanding by 0.3% in the first quarter. Officials said the sector "was not strong anywhere", with particular weakness in transport and communication. Manufacturing, where output declined in every quarter bar one in 2002 and 2003, was estimated to have grown in early 2003, despite the impact of growing international tension on exports.

In the US, only a slight narrowing in the record trade deficit saved the economy from even weaker growth, according to the bureau of economic analysis.