US growth figures take the pressure off interest rates

Economic growth in the United States in the first quarter has been revised up to an annual rate of 5.3%, the strongest for two and a half years, the Commerce Department said yesterday.

The revision was considerably less than analysts had forecast. It boosted US stock and bond prices as dealers felt that now the Federal Reserve would not have to raise interest rates much further. The market volatility over the past fortnight has been largely due to uncertainty about how high the Fed might push rates from their current 5% to rein in rising inflation.

The pace of growth from January to March was three times that of the last quarter of 2005 as activity rebounded after a slowdown caused by Hurricane Katrina. But Nariman Behravesh, economist at Global Insight, said the data represented the "last hurrah" of the economy's current expansion. "Based on the incoming data, we expect that US growth will slow in the second quarter to between 3% and 3.5%. We expect a further slowing of the growth momentum to below 3% in the second half.

"A soft landing in housing, along with a deceleration in consumer spending, will be key drivers of this growth slowdown. However, continued robust growth in capital spending and exports will prevent a more dramatic downturn."

He, like many other analysts, felt that rising inflation would prompt the Fed to raise rates at least once more before calling time on a phase of monetary tightening that began in June 2004 when rates were just 1%.

Separately, Britain's Office for National Statistics left its estimate of UK economic growth in the first quarter unchanged at 0.6% from the fourth quarter and 2.2% year-on-year. The detail, though, showed that consumer spending was weak in the first quarter but this was offset by the strength of industrial output and business investment.

The figures offered little clue as to the Bank of England's next move on interest rates. The growth rate was slightly below the economy's long-term trend but the Bank has forecast it will recover strongly throughout this year.

But consumer spending, which accounts for two-thirds of the economy, rose only 0.2% in the first quarter, its weakest growth since early last year. The Bank is predicting this will pick up again, especially in the current quarter, but some analysts are unconvinced.

"The best course of action in this situation is for the Bank to steer a steady course of rates for the foreseeable future, waiting to see if the consumer revives and the recovery in the eurozone entrenches," said Gavin Redknap, economist at Standard Chartered Bank.

"We think there's room for disappointment in both of these areas and as such expect the Bank to ease rates modestly in 2007."