Slow growth likely to peg interest rate

Hopes that interest rates would remain at 6% for the rest of the year were raised yesterday by news of a slowdown in economic growth.

Weaker activity in the services sector trimmed the pace of growth in the third quarter of this year, but it stayed above its long-term average.

Provisional data published by the office for national statistics showed GDP grew by 0.7% between July and September compared to the previous three months and was up by 2.9% over the year.

In the second quarter, the corresponding figures were 0.9% and 3.2%.

The slowdown was concentrated in the services sector, where output expanded by 0.7% in the quarter and 3.3% over the year, down from 0.9% and 3.5% in the second quarter.

After shrinking at the turn of the year, manufacturing recorded its second successive quarter of growth, although the ONS was unable to say by how much because of incomplete data. Philip Shaw, economist at Investec in the City, said that judging by the slowdown in services, manufacturing output probably accelerated to 0.6% from 0.4%.

"Certain areas of the sector, notably technology oriented firms, do seem to be thriving," he said. "However we would shy away from inferring that the economy as a whole is well balanced and instead remain of the view that the strength of sterling against the euro keeps alive the dangers of a two-speed economy."

The figures, which were in line with expectations in the City, gave ammunition to both sides of the interest rates debate.

Jonathan Loynes, of Capital Economics, said they would come as a relief to hawks on the Bank of England's monetary policy committee and meant that the cost of borrowing, on hold for the last eight months, had peaked at 6%.

But Geoff Dicks, of the Royal Bank of Scotland, pointed out that despite the slowdown, the economy was still growing above trend, reckoned to be about 0.6% a quarter or 2.5% a year, and putting upward pressure on capacity and inflation. According to his estimate, output is running at 1% above its assessed maximum.

Mr Shaw said the underlying strength of demand remained too strong to prevent one more quarter-point increase in rates, although he added that sterling's strength on the foreign exchanges probably meant it would be delayed until early next year.

The only thing that could spoil that relatively benign scenario would be a major pre-election giveaway by the chancellor Gordon Brown.

The ONS said the British economy has now had 33 successive quarters of growth since the bottom of the last recession in the second quarter of 1992, a post-war record.

Since then, GDP has grown by 27%, service sector output by 34% and manufacturing output by nearly 12%.

Previously, the longest expansion lasted 24 quarters from the third quarter of 1984 to the second quarter of 1990.