U.K. Economic Growth Matches Slowest Pace Since 2001

By Svenja O'Donnell

July 25 (Bloomberg) -- The U.K. economy expanded 0.2 percent in the second quarter, matching the slowest pace since 2001, as shrinking manufacturing and construction and the banking slump brought Britain closer to a recession.

Gross domestic product grew 1.6 percent from a year earlier, the least since 2005, the Office for National Statistics said in London today. The quarterly and annual growth figures both matched the median forecast of economists in a Bloomberg News survey.

``A recession is probable,'' said Steven Bell, chief economist at GLC Ltd. in London and a former U.K. Treasury official. ``We'll get negative growth for the next two quarters. We're now looking at quite deep interest-rate cuts next year.''

The economy's weakest outlook since the early 1990s is eroding support for Prime Minister Gordon Brown, whose ruling Labour Party yesterday lost a special election in Glasgow and must call a national vote by 2010. Higher credit costs and falling house prices have choked growth as inflation prevents the central bank from cutting the interest rate from the current 5 percent.

The U.K. is the first of the Group of Seven nations to announce GDP figures for the second quarter. While growth is slowing, the International Monetary Fund still expects the U.K. to perform better than the world's other major economies. Its forecast of 1.8 percent expansion this year compares with 1.3 percent for the U.S., 1.7 percent for the euro region and 1.5 percent for Japan.

Bank Losses

The pound erased an earlier decline and climbed as much as 0.3 percent to $1.9926 after the GDP figures. The 0.2 percent increase on the quarter matched the result for the first three months of 2005, which was the lowest since the second quarter of 2001, the statistics office said.

Business services and finance, which account for 28 percent of the economy, grew 0.1 percent on the quarter, the least in six years, the statistics office said. HSBC Holdings Plc, Royal Bank of Scotland Group Plc and other banks around the world have announced more than $481 billion in writedowns in the past year after the U.S. subprime mortgage slump roiled financial markets.

Manufacturing fell 0.4 percent, and a slowdown in homebuilding pushed construction down 0.7 percent, its first decline in more than two years.

Recession

Overall service industries, which account for about three- quarters of the economy, expanded 0.4 percent, compared with a 0.3 percent gain in the previous three months, the report showed. Industrial production, which includes manufacturing, mining, utilities and oil extraction contracted for a second quarter, fell 0.5 percent. It accounts for 19 percent of the economy.

Niesr, a group whose clients include the central bank and the Treasury, forecast today that Britain's gross domestic product will rise 1.5 percent this year, 1.4 percent in 2009 and 1.9 percent in 2010. That would be the worst performance since the three years through 1992.

Weakening growth may further erode Brown's support after his Labour Party lost a U.K. Parliament seat in Glasgow to the Scottish National Party, the government's biggest defeat in a special election since the invasion of Iraq five years ago.

Higher energy and food costs are curbing consumers' spending power, while the deepening housing market slump hurts their confidence. Retail sales fell 3.9 percent in June, the most since at least 1986, the Office for National Statistics said yesterday.

Faster Inflation

Faster inflation is also limiting the Bank of England's scope to help the economy with rate cuts. Consumer prices jumped 3.8 percent in June, almost double the central bank's 2 percent target. Policy maker Timothy Besley cast the first vote in a year for a rate increase this month. Seven of his colleagues kept the rate unchanged and David Blanchflower wanted a cut, citing the risk of a sharp slowdown.

Bank of England Deputy Governor Charles Bean said yesterday that the economy faces ``considerable'' risks from both growth and inflation.

At the same time, some economists argue that the Bank of England will eventually be forced to cut rates as growth slows. JPMorgan Chase & Co. today cut its rate forecast and now predicts the benchmark will fall to 4.25 percent next year. The implied yield on the June short-sterling futures contract has dropped one percentage point since June 19, falling to 5.48 percent.

``The point at which rates will begin to fall is coming nearer,'' said Malcolm Barr, an economist at JPMorgan in London.

U.K. unemployment jumped the most in June since the aftermath of the last recession in 1992 as the economic slowdown forced homebuilders and financial institutions to cut jobs.

Banks are curbing lending following the credit rout. HBOS Plc, the U.K.'s biggest mortgage lender, said this month that house prices, which tripled in the past decade, dropped in June from a year earlier by the most since 1992.

Bill Gross, manager of the world's biggest bond fund at Pacific Investment Management Co., yesterday said total writedowns could mount to more than $1 trillion, more than double the current estimate.

To contact the reporter on this story: Svenja O'Donnell in London at sodonnell@bloomberg.net.