Economy grows at slowest pace in 3 years

By Christina Fincher and Matt Falloon

LONDON (Reuters) - Britain's economy grew at its slowest pace in three years in the first quarter as surprisingly strong household spending failed to offset weaker industrial output and a sharp fall in business investment.

The figures back up a plethora of evidence pointing to a slowdown as the credit crunch impact starts to spread from the hard-hit financial sector, but markets expect the Bank of England to hold fire on any more interest rate cuts this year.

The Office for National Statistics confirmed on Friday that the economy grew an unrevised 0.4 percent in the first three months of the year, leaving the annual rate at 2.5 percent.

Analysts had not expected a revision and there was little market reaction. Despite slowing growth, inflation is rising well above the 2 percent target and investors are betting the next move in rates could be up.

However, strong price pressures are expected to eventually subside as the economy weakens and Bank Governor Mervyn King has indicated the economy could suffer the odd quarter or two of contraction.

"The BoE will tread extremely carefully on the interest rate path for the time being," said Howard Archer, an economist at Global Insight.

CONSUMER STRENGTH

A breakdown of the data showed a strong recovery in household spending, which rose 1.3 percent on the quarter, up from 0.1 percent in the last quarter of 2007. This reflected strength in official retail sales data which has diverged from weaker survey and anecdotal evidence.