Economy shrank even more than first thought in Q4

LONDON Fri Feb 25, 2011 1:51pm GMT

A sign points to the City of London financial district, in London February 16, 2011. REUTERS/Toby Melville

A sign points to the City of London financial district, in London February 16, 2011.

Credit: Reuters/Toby Melville

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LONDON (Reuters) - The economy suffered an even sharper slump than expected at the end of last year and would have shrunk slightly even without December's bad weather, official data showed on Friday.

The figures dented market expectations of any early rise in interest rates by the Bank of England, though analysts said a May increase was still on the cards.

Recent survey data suggest activity rebounded strongly early this year, and the government said the drop -- much of which was due to December's unusually severe weather -- would not throw its deficit-busting programme off track.

Friday's official data showed Britain's economy shrank by 0.6 percent between October and December, surprising analysts who thought last month's preliminary estimate of a 0.5 percent contraction would be unrevised.

Britain's Q4 performance looks dismal compared to its peers. Germany's economy expanded by 0.4 percent over the period and even France managed 0.3 percent growth. U.S. GDP figures on Friday showed annualised fourth-quarter growth revised down to 2.8 percent from 3.2 percent.

The weak UK data reinforce the case of those on the Bank's Monetary Policy Committee who think it is premature to start raising interest rates when the economy still faces severe headwinds.

Still, it is unlikely to break the momentum towards tighter policy after minutes this week showed three out of nine MPC members voted for an immediate rate rise from 0.5 percent in February.

The pound fell a third of a cent against the dollar and hit a one-month low against the euro as investors scaled back bets on a rise in interest rates in the next two months.

"Today's data will add to the concerns of the doves in the MPC who maintain that the recovery is still fragile, and will strengthen the case for a wait-and-see policy at least until it has become clear that the recovery is sustainable," said Blerina Uruci, economist at Barclays Capital.

ON THE REBOUND?

The Office for National Statistics stuck to its line that December's bad weather accounted for 0.5 percentage points of the fall in economic output, and it said the downgrade to GDP was mainly due to lower production and services output than it estimated last month.

But most analysts reckon the economy will enjoy a rebound in the first quarter of this year, as firms and consumers make up for time lost at the end of last year.

Indeed, recent purchasing managers' surveys indicate activity is picking up sharply, with manufacturers enjoying particularly robust demand thanks to the past fall in the pound.

Many analysts still expect the BoE to start raising rates in May to tackle inflation, which is currently running at double the central bank's 2 percent target.

"I think May is still on the cards," said Richard Barwell, economist at RBS. "This is one bad quarter and we think it will come back in Q1."

BELT TIGHTENING

Friday's data showed household spending fell 0.1 percent on the quarter -- suggesting Britons were tightening their belts even before a January rise in value added tax, and boding ill for consumption once public sector spending cuts kick in.

Surveys show consumer morale remains in the doldrums, and stores have also been having a hard time, with retail bellwether John Lewis on Friday reporting a fifth week of poor sales.

A survey by the Confederation of British Industry showed retail sales growth slowed to an 8-month low in February, and looked set to deteriorate further.

Britain's economic recovery looks set to be sluggish this year as the government embarks on its deepest spending cuts in generations to reduce a record budget deficit.

Without government spending, which rose by 0.7 percent on the quarter, the decline in Q4 GDP would have been even sharper.

"This is fairly worrying given we know about the wave of fiscal austerity that is now starting to hit the UK economy," said James Knightley, economist at ING.

And while policymakers will be dismayed by rising price pressures -- the implied deflator shot up to 1.0 percent on the quarter from 0.3 percent in Q3 2010 -- they will probably want more reassurance that the recovery is back on track before pulling the trigger on rates.

"There is no prospect of any moves before the Q1 data becomes available at the end of April and even then a rate hike is not the foregone conclusion that markets appear to think it is," said Andrew Goodwin, economic adviser to the Ernst & Young ITEM Club.

(Editing by Stephen Nisbet)

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