Bank set to cut growth forecast as UK and US economies falter

The Bank of England looks set to cut its growth forecasts below the Treasury's next month after figures yesterday showed the economy has slowed sharply so far this year.

The revision would open the way for the Bank's Monetary Policy Committee to cut interest rates in an attempt to prop up a weakening consumer economy. GDP growth slowed to 0.2 per cent in the first three months of the year, half the 0.4 per cent increase in the final quarter of 2002. The economy has not grown more slowly since the end of the recession in 1992. The gloom was compounded by a similar disappointing fall in US growth, pointing to a synchronised slowdown.

In February the Bank forecast 2.5 per cent growth this year – a figure economists in the City said was now almost unachievable without a massive rebound in the second half of the year.

Martin Essex, a senior economist at Capital Economics, said: "Even to reach 2 per cent, quarterly growth rates of 0.5 per cent are needed, and this is by no means assured. We believe the Bank will reach the same conclusion in May and reduce its growth forecast closer to 2 per cent or even less."

A cut below 2 per cent would put it under the Treasury's 2 to 2.5 per cent range. It would be a fresh embarrassment after criticism from the International Monetary Fund and the OECD.

The Treasury, which forecast a rebound in the second half of this year, was quick to blame the war. "No country can be immune from the global events of recent months with, throughout the first quarter, falls in global equity markets, volatility in oil prices and military uncertainties surrounding the global economic outlook," a spokesman said.

But economists warned it was not clear all of the slowdown could be explained by uncertainty over the war in Iraq.

Martin Weale, the director of the National Institute of Economic and Social Research, said the main factor was the slowdown in retail sales over the three months. "We see weak growth as a consumer downturn rather than something caused by the war in Iraq," he said.

Retail sales, workers' earnings, house prices and mortgage borrowing have all pointed to a fall in consumer wealth in recent weeks.

Yesterday's figures showed the slowdown was driven by the services sector, which makes up two-thirds of the economy. While construction enjoyed "strong" growth and manufacturing boasted a surprise rebound, services grew just 0.3 per cent, compared with 0.5 per cent in the previous quarter. A government statistician said: "Growth was not particularly strong anywhere. There was very little change in transport and communication. Growth was subdued in distribution, hotels and catering, business services and finance and government and other services."

Hotels and restaurants in particular showed a marked decline, indicating tourism dried up ahead of the war. On Thursday InterContinental Hotels axed 800 jobs after profits fell sharply as US visitors stayed away.

Philip Shaw, the chief UK economist at Investec Bank, said: "The figures should help to build up the momentum for a rate cut ahead of the MPC meeting on 8 May." But he warned one obstacle was the inflationary implications of the pound's 4 per cent depreciation since February.

Sterling fell further after the figures were released as the financial markets priced in a rate cut. Stock markets fell as the weak economic growth on either side of the Atlantic and worries over the deadly Sars virus dented hopes of a revival in corporate profits. The sell-off was led by Wall Street, where the Dow Jones fell as much as 133 points in early trade. The US economy grew at an annualised rate of 1.6 per cent in the first quarter, disappointing hopes of a marked rebound from the previous quarter's 1.4 per cent. In London the FTSE 100 was down 290 points.