Growth stalls but rates still expected to rise

The City was left disappointed yesterday as economic growth figures for the first quarter were not revised higher, but economists still believe interest rates will rise in the coming months.

Official data showed gross domestic product grew 0.6% on the quarter, the same figure as the preliminary estimate, giving an annual rise of 3%. Economists and the Bank of England had expected an upward revision because survey data in recent weeks has been strong.

The figures showed the economy growing much slower than the previous two quarters and still perilously unbalanced, with service sector growth revised up to 0.9% in the first three months of the year but industrial output revised down to a fall of 0.6%.

Household expenditure rose a healthy 0.9% on the quarter and government spending was up 0.7% but the main drag on growth was net exports, hit by a strong pound and slow growth in the eurozone - Britain's biggest trading partner. Net exports reduced overall growth by 0.4 percentage points, similar to the previous two quarters.

"Growth remains completely unbalanced with strong domestic demand but a big net trade contraction," said John Butler, economist at HSBC.

Economists were divided as to what the figures meant the Bank of England would do at its next interest rate meeting. Most felt that as the 0.6% figure was known at the Bank's meeting earlier this month, at which it raised rates and gave a warning of more rises to come, the Bank would be likely to put rates up to 4.5% at its early June meeting - the fourth rise since November.

"We think that the Bank of England was sceptical of this growth data in its May inflation report and see no reason for that scepticism to have changed today. We still expect the MPC to increase rates to 4.5% at its June meeting," said David Page at Investec bank.

Others, including Jonathan Loynes at Capital Economics and Richard Iley at BNP Paribas, thought the Bank might be getting ahead of itself, given that growth was lower than the Bank had estimated and inflation was still well below its government-set target of 2%. "The picture of fairly moderate and yet still unbalanced growth in the UK economy ... will make it difficult for the monetary policy committee to justify raising interest rates for a second consecutive month in June," said Mr Loynes.

Separately, a report from Ernst & Young showed Britain, along with France, was the major recipient of foreign direct investment in Europe last year. The total number of new projects in Europe was up 2% to 1,933 but in Britain the number jumped to 453 from 370 the year before and in France to 313 from 254.

The rise was largely driven by new investment in existing projects rather than new projects. The main source of the investment in Britain was the US, while France's was the rest of Europe. "The relative success of the UK in attracting foreign investment reflects the strength of the domestic economy and its position in the economic cycle," said Barry Bright, the head of E&Y's European Investment Monitor.