The economy slowed to its weakest in three years in the first quarter despite badly squeezed households drastically cutting back on saving to shore-up their spending, official figures showed today.

Bleak revised figures cut the economy’s reported growth in the first quarter to 0.3 per cent, from the previously estimated pace of 0.4 per cent, to mark Britain’s weakest economic performance since the start of 2005.

City fears that an even sharper slowdown may grip the economy in the rest of the year mounted as the GDP figures also revealed that families saved less out of their incomes in the first three months of this year than at any time since the end of 1959.

The so-called savings ratio, the key official measure of what Britain’s households are putting aside from their pay, tumbled to just 1.1 per cent in the first quarter, just over a third of the 3 per cent figure for the previous quarter.

The severe drop in savings came as families faced a still tighter squeeze on their living standards, with take-home pay falling in the first quarter, after accounting for sharply rising inflation, as well as bigger interest payments triggered by the credit crunch, and higher taxes.

Even after generous increases in wages in the quarter, inflation, interest bills and taxes left real disposable incomes falling, by 1 per cent in the first quarter, reversing a 1 per cent rise in the previous quarter.

Despite the drop in their spending power, today’s figures suggested that consumers resorted to radically cutting back on saving, rather than shunning the shops.

Consumer spending rose by a buoyant 1.1 per cent in the first quarter. This was revised down from a previous estimate of a 1.3 per cent increase but remained more than double the 0.4 per cent reported rise for the final quarter of last year.

But economists sounded warnings that with inflation eating into family budgets, disposable incomes falling, and households resorting to curbing their savings, consumers were set to go into retreat, weakening the economy still more in the rest of the year.

“This reinforces belief that consumer spending is set to be reined in for an extended time, especially as rising inflation is increasingly squeezing purchasing power,” said Howard Archer, chief UK and European economist at Global Insight.

The weakness of growth in the first quarter already confirmed by today’s figures was driven by a steep drop in investment by anxious businesses, and as they cut back their stocks to brace themselves for potential falls in demand from customers.

Overall investment by companies and the Government fell by 1.5 per cent in the first quarter, with business investment plunging by 1.8 per cent. Growth was also hit as output from industry fell by 0.2 per cent.

The vast services sector, the engine room of the economy, was a key area of weakness, with its growth dropping to a meagre 0.3 per cent, half the pace of the previous three months and the lowest for more than 12 years.

Services activity was dealt a heavy blow by the worst performance by the key business services and financial sector for nearly five years, in a poor showing that was blamed on the continued toll from the credit crunch.

That toll was also at work as Britain’s balance of payments deficit on the current account fell in the first quarter to £8.4 billion, from £12.4 billion in the previous quarter.

The deficit was reduced by losses on foreign-owned investment banks based in the UK. Normally, profits made by these banks being sent back to their base abroad, adds to the deficit.

Economists said that the increasingly poor outlook for Britain suggested by this morning’s figures would help to stave off the increasing threat of an interest rate rise by the Bank of England as it battles to combat inflation.

Yesterday, five of the nine members of the Bank’s rate-setting Monetary Policy Committee, indicated in evidence to MPs that they had contemplated a rate increase this month.

But analysts said that confirmation of the economy’s growing frailty in today’s national accounts figures should be sufficient to persuade the Bank to keep base rates on hold for the next few months.

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