The dollar tumbled on currency markets yesterday, pushing the euro to record highs, after news that the US economy had slowed to its weakest for four years during the first quarter stoked fears over American economic prospects.

Anxieties over the outlook were fuelled as the abrupt slow-down in growth, to half the pace of the previous three months, came alongside a doubling in a key measure of inflation.

The malign combination of rapidly softening growth caused by the toll from the US housing market’s slump with persistent inflationary pressures dealt a blow to hopes that the Federal Reserve could shore-up recovery with early cuts in interest rates.

Yet the prospect that the Fed may shy away from lowering rates did little to bolster the dollar in the face of nervousness over future growth.

Mounting unease over economic prospects sent the greenback tumbling against rival currencies and drove the euro to its highest dollar value, at $1.3682, before later it lost a little ground to stand at $1.3626 in early afternoon dealing in New York.

The pound also rose sharply, climbing back above the $2 barrier, to close in London at $2.0020, up more than a cent on the day.

Economists sounded immediate warnings that there could be worse news to come on growth in the present quarter. The US economy’s first quarter expansion was underpinned by still-strong consumer demand, which grew at a robust annual equivalent rate of 3.8 per cent, only a little weaker than the 4.2 per cent rate in the previous three months.

Analysts said that consumer spending could drop back significantly in the second quarter as rising energy and fuel bills hit Americans hard in the pocket.

Worries that consumer spending could wilt were heightened yesterday as a key gauge of households’ confidence dropped for a third month in a row to a seven-month low. The regular index of sentiment from the University of Michigan fell to 87.1 for this month, from a March reading of 88.4.

Economists also said that a rebound in business investment growth in the first quarter (Q1) may not persist. Investment rose at an annual rate of 2 per cent in Q1, after falling by 3.1 per cent in the previous three months. But with corporate profitability in the United States slowing, analysts said that companies might start to retrench.

The biggest blow to Q1 growth came from residential construction spending, which fell at an annual rate of 17 per cent in Q1, marking a fourth quarter of double-digit decline as the impact of the housing market downturn continues.

Scope for the Fed to cut interest rates was reduced by a jump in the GDP-based measure of prices across the US economy. This showed inflation running at an annual 4 per cent in Q1, drastically up from 1.7 per cent

Explore Economics

• Pre-Budget Report 2009

• Budget 2009

• World Economic Forum in Davos

• The Times MPC

Times Recommends

• Toyota recalls 437,000 cars including Lexus
• Myners says bonuses are bleeding pension funds
• Japanese company faked safety reports on seats