Instant View - Economy grows 0.5 percent in Q1, as expected

LONDON (Reuters) - The economy made only a feeble recovery in the first quarter of this year, barely making up for the surprise contraction at the end of 2010, official data showed on Wednesday.

The figures, which show the economy has stagnated since last September, mean UK interest rates look set to stay at record lows until much later this year.

KEY POINTS

- Biggest quarterly drop in construction output since Q1 2009

- Biggest quarterly rise in services output since Q4 2006

- The Office for National Statistics said Q1 GDP growth was essentially an arithmetic effect following Q4's 0.5 percent drop. It said the underlying picture in Q1 was broadly flat and the level of GDP in Q1 was the same as in Q3 2010.

ANALYST COMMENT HOWARD ARCHER, GLOBAL INSIGHT

"One crumb of comfort is that the underlying performance looks a little stronger than indicated by the headline GDP figure.

"GDP growth in the first quarter was pulled down by a plunge in construction output and a sharp drop in utilities output. These sectors can be very volatile and it is notable that service sector activity saw a reasonable bounce back in the first quarter and manufacturing output held up well.

"Nevertheless, with fiscal headwinds mounting and consumers' purchasing power squeezed, the outlook is worrying. We currently forecast the economy to grow by 1.5 percent in 2011, but it could well struggle to achieve that rate.

"This has particularly worrying implications for the Chancellor (finance minister George Osborne) as his targeted reduction in the Public Sector Borrowing Requirement to 122 billion pounds in fiscal year 2011/12 is based on GDP growth of 1.7 percent.

"The GDP data not only look to have killed off any prospect for an interest rate in May, but also significantly increase the likelihood that the Bank of England will hold fire for several months to come. In fact, we are putting back our expectation for the first interest rate hike from August to November."

ROB CARNELL, ING

"Markets had been expecting something even worse, following reports that the Chancellor George Osborne had described economic conditions as 'difficult' following his advance viewing of the data.

"A 0.5 percent rise is in fact a better outcome than it first appears. Not all of the growth in the first quarter will have been a bounce back from snow in the fourth quarter, so there does appear to be some underlying growth here."

"Clearly, UK growth is still a struggle, but it is still moving forward. Today's figures provide some support for the government's argument that the pace of fiscal consolidation will not derail the economy, and that deficit reduction measures remain manageable for the economy.

"However, they do not provide the Bank of England with enough of an excuse to respond to high headline inflation with tighter policy. A May rate hike still seems a tough proposition at this stage."

VICKY REDWOOD, CAPITAL ECONOMICS

"The UK GDP figures suggest that underlying activity in the economy remains pretty much stagnant. The 0.5 percent quarterly rise in output means that the economy did nothing more than reverse Q4's snow-related dip.

"In fact, if there was some temporary "catch-up" of output lost in Q4, then underlying growth may even have been slightly negative.

"Admittedly, the rise was in line with expectations: in fact, markets appear to be a bit relieved that the number was not even weaker. But given the sense of gloom that has recently descended about the Q1 figure, this is hardly a consolation.

"Indeed, note that the figure is weaker than the 0.8 percent rise than both the MPC and OBR had pencilled into their most recent forecasts.

"With consumers clearly retrenching, we doubt that growth will pick up much speed during the rest of the year -- indeed, our forecast of just 1.5 percent growth in 2011 as a whole now looks pretty testing. The chances of an interest rate rise next month just got even slimmer."

DAVID PAGE, LLOYDS

"They're not wildly surprising. We thought there was a risk the numbers could be a little softer. We were pleased to see services pick up but part of that is due to the weather rebound."

"We would treat these numbers with a degree of suspicion. The construction fall we would expect to fade over time."

"I think the underlying pace of the domestic economy is still soft. If you assume the weather effect is smoothed, then effectively growth is zero over the past two quarters."

"This reinforces the point that the MPC is going to view the domestic recovery is too fragile to tighten just yet."

DAVID OWEN, JEFFERIES INTERNATIONAL LIMITED

"Given the briefing of the Cabinet by George Osborne, this is probably on the day slightly better than expectations. But I think politically, GDP is now basically unchanged over the last six months, and so it does bring into question some degree of political risk in the market because we have got these important elections occurring next Thursday, and there has been some speculation about growing risks in the coalition.

"In terms of the monetary policy decision, this is of no interest whatsoever but politically it's of more interest."

HETAL MEHTA, DAIWA CAPITAL MARKETS EUROPE

"Today's figures suggest underlying growth in the UK economy is virtually non-existent.

"Before the snow hit in December, it was widely expected that GDP would be hit in Q1 once VAT had gone up.

"So even when you allow for the snow, and some 'catch up' of lost output, this leaves the economy having flat-lined for the past six months.

"And with the full force of the public spending cuts yet to be unleashed, there is little reason to expect GDP growth to pick up much in the second quarter.

"We see the first rate increase in August but the risks are very much skewed to pushing that back."

PHILIP SHAW, INVESTEC

"At face value, all the economy has done is overturn the half percent decline in output in Q4 which was largely attributable to the snow, which implies the underlying path of the economy is flat."

"But we suspect the numbers may be underestimating the path of the economy. The latest figures suggest that construction figures fell by 5 percent on the quarter, compared to a period where the sector was disrupted severely by the snow."

"There appears to be an considerable degree of volatility in the construction figures, which means we take the preliminary GDP figures with a pinch of salt."

"In terms of monetary policy implications, there certainly aren't any domestic demand led (inflation) pressures in the economy. We remain of the view that the fragility of consumer spending will result in rates being kept on hold next week."

ROSS WALKER, RBS FINANCIAL MARKETS

"Pretty much as expected both in terms of the headline print and the breakdowns. It's not disastrous, but it is a bit lacklustre.

"We have basically just taken back the fourth quarter fall, so the underlying economic environment since the autumn looks a bit flat.

"You do have what looks to me like a surprisingly large fall in construction output. Do we really believe that the level of construction output was lower in January than in December? We may well see some revisions here.

"It's going to be a bit below what the Bank of England had factored in back in the February inflation report. But since then Martin Weale and Spencer Dale have alluded to growth being a tad softer.

"So I don't think the print is going to be a huge surprise, but it is a little weaker than what would have been factored into the BoE's February forecast."

GEORGE BUCKLEY, DEUTSCHE BANK

"It's in line with expectations. But when you look at the proportion of the economy which is expanding quite well, it's not that bad. What really dragged this number down was only eight percent of the economy -- we're talking about energy production and construction. If it had not been for them, GDP would have expanded more significantly."