UK economy slows in third quarter

Manufacturing output has slowed

The UK's economic growth slowed in the third quarter, as recent interest rate rises hit home.

Gross domestic output (GDP) increased 0.4% in the three months to September, according to provisional figures from the Office for National Statistics.

The slowdown in growth is thought to makes it less likely that the Bank of England will raise interest rates.

It could also create problems for Chancellor Gordon Brown's budget, as slower growth means lower tax revenues.

Manufacturing decline

The figure represents the weakest pace of growth since the first quarter of last year.

Then slower growth was linked to the fact that the Iraq war had damaged business and consumer confidence.

It is unlikely we will see another change in rates this year David Page, Investec Securities

The third-quarter figure compares unfavourably to the first two quarters of 2004, where the UK economy grew 0.7% and 0.9% respectively.

The slowdown was attributed to a 1.1% decline in industrial production, which includes manufacturing, mining and oil refining and accounts for about one fifth of the country's economy.

In contrast, the service sector performed strongly, growing by 0.8%.

The latest figures show that the retail and hospitality sectors performed strongly over the period.

Transport, storage, business services and finance sectors also enjoyed growth.

Desired effect

It now appears increasingly likely that interest rates will remain at their current level of 4.75% for the rest of the year.

The Bank of England's Monetary Policy Committee (MPC) will make its next interest rate decision on 4 November.

Interest rates are expected to stay on hold in November

David Page, an analyst at Investec Securities, said: "It's unlikely we will see another change in rates this year. There is too much uncertainty and the [Bank of England's] MPC will want to take their time."

Manufacturers' association EEF said the figures overstated the slowdown in the manufacturing sector.

However, the EEF's chief economist Steve Radley said the Bank of England needed to tread carefully when considering future interest rate changes.

"Continued rises in the costs of oil, energy and metals will ultimately weaken markets as well as eat into profit margins," he said.

"Together with evidence of a housing market slowdown, this suggests rates should stay on hold until at least the New Year."

Concerned about the strength of consumer spending and overheating in the housing market, the Bank raised interest rates five times between November 2003 and August.

The increases seem to have had their desired effect with key indicators showing a slowdown in economic activity in recent months.

The forecasts of both the MPC and the Chancellor are already starting to look far too optimistic Jonathan Loynes, Capital Economics

Retailers reported their weakest sales for eighteen months in September, according to a CBI survey.

The housing market also appears to be cooling off.

The market grew 0.2% in September, according to figures from the Nationwide Building Society, after a 0.1% rise in August.

Golden rule

Any prolonged slowdown in economic growth could cause real problems for Gordon Brown ahead of next year's election.

Accountancy firm Ernst & Young said recently that the Chancellor is facing a £6bn shortfall in tax revenues and may have to raise taxes soon after the election.

According to E&Y, Mr Brown is in danger of breaking his "golden rule" -which states that the government may only borrow to invest over the course of the economic cycle -because forecasts for tax revenues were too optimistic.

Jonathan Loynes, chief UK economist for Capital Economics, said it was increasingly likely that interest rates had peaked and could even come down next year.

"The economy is still set to expand by a pretty robust 3% or more this year," he said.

"However, the forecasts of both the MPC and the Chancellor that it will grow by a similar amount next year are already starting to look far too optimistic."