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GDP shock puts early rise in interest rates under question

News that the economy shrank 0.5% in the fourth quarter of last year pours cold water on the idea of the Bank of England raising interest rates early in a bid to quash inflation.

The UK economy shrank by 0.5% in the last three months of 2010 as the bad weather hit retailers, restaurants and the building sector.

Economists had been revising down their growth expectations after the winter snow and as recent data showed retail sales and restaurant takings had been hit hard but still the consensus was for 0.4% growth in the fourth quarter.

There was more bad news as the data for the previous quarter was revised down and the Office of National Statistics now believes the economy grew just 0.7% in the three months to the end of September.

Economy Shrinks 0.5%

Official data from the government showed the services sector, which accounts for around three quarters of the economy, shrank by 0.5% and the construction sector shrank 3.3%. But there was some small good news in that the weak pound has helped to boost the manufacturing sector with output there up 0.9%.

More recent data suggests that consumers have been reluctant to spend at the start of the year as government spending cuts, higher prices, fear of interest rate increases and the new, higher rate of VAT all weighed.

Chris Williamson, chief economist at business surveys group Markit, said: 'The insight we have so far for January, such as information on household finances, suggests that the consumer will have acted as an increasing drag on economic growth at the start of the year.' 

But few believe this grim news will be repeated in 2011 or that the UK is heading back into recession.

Jonathan Loynes, chief UK economist at Capital Economics, said: ‘Presumably GDP growth will now rebound pretty strongly in Q1, as it did after weather effects in Q4 2009.'

'The data will surely cause the Bank of England's Monetary Policy Committee to pause for thought before considering any rate rise to ward off current inflationary pressures,' said Williamson. 

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