Economy makes feeble recovery in first quarter

The sun rises above the financial district of the City of London April 23, 2011.

LONDON (Reuters) - The economy made only a sluggish start to 2011 as it crawled back from a slump at the end of last year, snuffing out chances of a Bank of England rate rise next week and hampering the government's austerity drive.

Prime Minister David Cameron took some heart from healthy growth in key sectors such as manufacturing, though opposition politicians and businesses warned that spending cuts, tax rises and high inflation would hit consumers.

Overall output expanded 0.5 percent in the first three months of the year after declining by the same amount at the end of 2010 as construction posted its biggest drop since the height of Britain's worst recession since World War Two.

After a solid recovery for most of the past year, Britain's economy has effectively flatlined since September and is now trailing well behind its developed world peers.

"Underlying activity in the economy remains pretty much stagnant," said Capital Economics economist Vicky Redwood. "The economy did nothing more than reverse Q4's snow-related dip."

Wednesday's figures set the stage for a tough 2011 as the government starts in earnest with a four-year program of public spending cuts.

The recovery in the first quarter was weaker than either the Bank of England or the Office for Budget Responsibility had pencilled in and raises the risk that government tax revenues will fall short of target.

Most Bank policymakers want to see a sustainable recovery before tightening monetary policy, meaning interest rates are likely to stay at record lows at least until July despite inflation running at twice the bank's 2 percent target.

A Reuters poll of 62 economists taken before the GDP data and published Wednesday gave just a 30 percent chance the bank would act on rates before the middle of the year, down from 45 percent in a poll taken last month.

RELIEF RALLY

Investors had already braced for a weak growth number following dismal data on construction and consumer spending in recent weeks.

Sterling rallied on relief that the biggest drag to growth had come from volatile sectors including utilities as well as construction, and London's benchmark stock index pushed into positive territory.

"Once erratic swings in construction are stripped out, the economy has shown underlying growth in the last two quarters," said Michael Saunders, UK economist at Citi.

"This is not so bad given the heavy headwinds from fiscal tightening and high inflation."

Key sectors of the economy, such as manufacturing and services grew at a healthy pace, recording progress of 1.1 and 0.9 percent respectively. Business services and finance expanded by 1.0 percent, its best reading since 2007.

Construction fell 4.7 percent, its biggest fall since the height of Britain's recession in the first quarter of 2009. But the extent of the decline, not corroborated by survey evidence, aroused suspicions that revisions were on the cards.

OUTLOOK STILL MURKY

The government welcomed the economy's return to growth and said the recovery was always going to be choppy. But opposition Labour's finance spokesman Ed Balls said the government's spending cuts were choking off the rebound.

Business Secretary Vince Cable blamed banks' reluctance to lend for holding up the recovery and said fresh measures may be needed. Figures last week showing negative lending to small enterprises were "clearly very disappointing indeed," he added.

After snow disruption at the end of 2010, effects of a late Easter and one-off public holiday for the Royal Wedding will continue to cloud the view of policymakers.

One economist said there could be a decent bounce in the second quarter. "The details of the data suggest there should be a significant bounce in GDP growth in Q2 to between 0.75 and 1 percent," said Brian Hilliard at Societe Generale.

But evidence from the corporate sector suggested cash-strapped Britons are becoming more price conscious.

Discount fashion retailer Primark said Wednesday that its women's spring and summer ranges were selling well, with the British High Street in better shape over the last two months, but that it would also cut margins to absorb spiralling costs.

And as Premier Foods, the maker of Hovis bread and Bisto gravy, cautioned that confidence remained at a "pretty low level," a survey showed discount supermarkets Aldi and Lidl are taking record shares of the UK grocery market.

(Editing by Patrick Graham, John Stonestreet)