Growth in the economy fell to its weakest in three years in the first quarter as the credit crunch sapped activity in key parts of the services sector, official figures showed yesterday.

A marked slowdown in business services and finance, along with a sharp drop in North Sea output, triggered a fall in GDP growth to 0.4 per cent in the first three months of the year (Q1), down from 0.6 per cent in the previous quarter to mark the slowest expansion since the start of 2005.

The poor performance was underlined as annual GDP growth also fell back to 2.5 per cent in Q1, taking it below its long-term average trend rate and sparking new warnings from economists of worse to come.

The economy's lacklustre first quarter showing would have been still weaker but for surprisingly strong growth in both the manufacturing and the retailing sectors.

Confounding fears that a squeeze on consumers' pockets would undercut household spending, the data showed that output in the distribution, hotels and catering sector rebounded, rising from an anaemic 0.2 per cent in the final quarter of last year to a buoyant 0.9 per cent in Q1.

However, after City economists and retailers challenged official retail sales figures as excessively strong and at odds with other evidence this week, analysts said that the GDP data could yet prove vulnerable to being revised down.

Growth in manufacturing also added impetus to economic activity in the first quarter, with manufacturing output recording a robust 0.5 per cent rise, as industry appeared to have capitalised on the pound's recent weakness to boost exports.

The broader measures of industrial production fell by 0.1per cent in the first quarter, mainly due to steep falls in North Sea oil and gas extraction, and a more modest drop in output from utilities companies.

The key source of the economy's weakness at the start of the year was the services sector outside the distribution and retail industries. Overall growth in the services sector fell to a three-year low of 0.6 per cent in the quarter, from 0.7 per cent in the previous three months.

Business services and finance sector output fell to 0.4 per cent, from 0.6 per cent, marking these industries' worst performance for nearly five years. Growth of government services also fell back sharply, to 0.4per cent from 0.7per cent as the first effects of the Chancellor's three-year squeeze on public spending growth were felt.

The slowdown in the first quarter will add to the case for the Bank of England to deliver further interest rate cuts in coming months. The annual pace of the economy's expansion, at 2.5 per cent, is 0.2 percentage points below the rate expected in the Bank's February forecasts.

However, economists said that the MPC was likely to remain cautious given the mixed evidence of trends in consumer demand, in particular, and its continued anxieties over persistent inflationary dangers.

The Bank will note the latest snapshot of expectations of future inflation among households in a poll by YouGov for Citigroup. This showed the average expected level of inflation in the coming year up at a record of 3.8 per cent this month.

A key worry for the MPC is that increases in the cost of living will lead people to expect higher prices and increase their wage demands, stoking inflationary pressures.

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