Growth seen slowing sharply in third quarter

A shopper passes an advertisement on a shop in Oxford Street in London September 30, 2010.

WHAT: UK third-quarter GDP data (first estimate)

WHEN: Tuesday, October 26 at 0830 GMT

REUTERS FORECAST: +0.4 pct q/q (Q2 +1.2 pct), +2.4 pct y/y

FACTORS TO WATCH

Economists polled by Reuters are unanimous that Britain's quarterly rate of GDP growth will slow sharply from the second quarter's nine-year high of 1.2 percent, with forecasts ranging from a 0.8 percent rise in GDP to a 0.2 percent decline.

Growth is expected to slow further in early 2011 on rising headwinds from the government's four-year programme to slash spending, including cutting departmental spending by a fifth, and a second successive annual rise in value-added tax.

Second-quarter GDP was boosted by one-off construction gains after the harshest winter in decades, a fall in household saving and a big rise in government spending ahead of the severe austerity drive, which many analysts say will hamper the economic recovery.

The median forecast for a fall in third-quarter GDP growth to 0.4 percent would take it below its trend rate of around 0.6 percent.

"With the fiscal squeeze not yet fully underway, a figure in this region would clearly cast further doubt on the ability of the coalition to force through a painful fiscal tightening without throwing the economy back into recession," said Capital Economics analyst Samuel Tombs.

Other economists view 0.4 percent third-quarter growth as consistent with forecasts for quarterly expansion of around 0.2-0.3 percent in the first half of 2011, still below government forecasts.

Official data showed that service sector output -- which makes up about three quarters of the economy -- dropped in July as well as June, and remained weak in August and September according to industry surveys.

Economists estimate that industrial output in July-September grew at around half its second-quarter pace, based on data for July and August -- though this was volatile due to an earlier-than-usual disruption from summer maintenance work to North Sea oil rigs.

A Reuters poll this month forecast Britain's economy is on course to grow 1.6 percent this year and 1.8 percent in 2011, well below a pre-recession average of almost 3 percent annually.

MARKET IMPACT

A weaker-than-expected reading is likely to give a strong boost to gilt prices and put sterling under pressure versus the dollar and euro. This is not just because of weaker growth and inflation prospects going forward but because it raises the chance that the Bank of England will do more quantitative easing (QE).

An in-line GDP estimate would be unlikely to decisively shift the BoE towards adding to the 200 billion pounds of gilt purchases it made between March 2009 and January this year.

"The most likely market spin is that this sub-potential outcome will keep the doves energised, but the lack of a more onerous downturn will keep the hawks unconvinced of the need for further stimulus with inflation still so high," said Credit Agricole currency strategist Daragh Maher.

By contrast a stronger reading would boost share prices and sterling, and hurt gilts. But it would be unlikely to quash all QE hopes, as these are based on the expectation that the economy will slow sharply next year when government spending cuts and tax rises bite.

(Reporting by David Milliken; Editing by Susan Fenton)