Sinking into severe recession, the UK economy contracted more than expected in the first three months of the year, logging its biggest shrinkage since the third quarter of 1979 and casting doubts on the Chancellor's economic predictions.

Data released by the Office for National Statistics or ONS on Friday showed that the gross domestic product declined 1.9% in the first quarter, while economists were looking for a milder figure of 1.5%. The deterioration worsened from the final quarter of 2008, when the economy had shrunk 1.6%.

The latest contraction is the biggest since the early days of the Margaret Thatcher government in 1979. The GDP number has been in the red since the third quarter of 2008. Further, it is reportedly the worst six-month decline in GDP since the start of official records.

The slowdown was the result of both reduced services and production activity, the ONS said. This is the first instance after records commenced after World War II that the economy shrunk more than 1% for two quarters in a row.

Year-on-year, the GDP dropped 4.1% in the first quarter compared with a 2% fall in the previous quarter. The latest annual decline is the biggest since 1980. Economists had expected a 3.8% fall.

Breaking down numbers, the ONS report showed that manufacturing recorded the worst result during the quarter, falling 6.2% after a 4.9% slide in the previous quarter. The latest result is the weakest since 1948. Overall production fell 5.5% in the first quarter, after declining 4.5% previously.

The services sector, which accounts for 75% of the economy, shrank 1.2% in the first three months, worse than the 0.8% deterioration in the previous quarter. Output of business services and finance sector decreased 1.8%, the most since the series began in 1983, after a 0.5% dip logged in the previous quarter.

UK is the first nation in the G7 grouping to release first quarter GDP figures. The grim data came in a week when the government announced its latest GDP forecasts, which were widely seen optimistic. The Budget on April 22 that revealed record borrowing for a year, sparked rumors of possible downgrade to UK's credit rating.

In his second budget statement, Chancellor Alistair Darling predicted a 3.5% contraction for UK economy this year, the worst since the Second World War. In November, the government had forecast shrinkage of nearly 1.2%. For the first quarter, Darling was expecting a repeat of the 1.6% GDP decline seen in the final three months of 2008.

Going forward, the Chancellor expects the economy to resume growth by the end of this year and grow 1.25% next year. From 2011, the government estimates the economy to continue its recovery, with growth of 3.5% from then on.

In contrast, the Washington-based International Monetary Fund said on the same day that the UK economy may contract 0.4% in 2010 after shrinking 4.1% in 2009.

Commenting on the latest data, the Confederation of British Industry said, Looking ahead, the best we can say is that the pace of economic decline may slow in the coming months. Given that unemployment will continue rising sharply, even if businesses begin to see the rate of decline in activity starting to ease, consumers are likely to feel anxious about job prospects.

At the start of the week, the business lobby forecast a slow and fragile recovery in the UK with growth resuming only in the spring of 2010. The CBI revised down its GDP forecast for 2009 to a 3.9% contraction compared to an earlier estimate of a 3.3% GDP decline.

Meanwhile, data released separately on Friday showed that UK retail sales unexpectedly rose in March, up 0.3% month-on-month. Economists' were looking for a decline of 0.3%. Retail sales had declined in February. On an annual basis, retail sales increased 1.5% in March, larger than the 1.1% forecast by economists.

Citing the sharp decline in household goods sales, Commerzbank economist Peter Dixon said, It is notable that the CPI figures show that this is one area where prices are rising rapidly, and indicates that consumers remain sensitive to prices at a time when their personal finances are being squeezed.

The annual rate of change in retail prices turned negative in March for the first time since 1960. The government expects retail price inflation to remain negative, falling to minus 3% by September, before moving back above zero next year.

The Gordon Brown government, which will face an election next year, has announced several measures to prevent the economy from sinking into deep recession.

Public sector net borrowing is set to be a record GBP 175 billion this year or around 12.4% of GDP. Darling raised the tax rate to 50% for incomes above GBP 150,000 from the earlier announced 45%. This will take effect next April.

Darling also announced a car scrappage plan that will give motorists a GBP 2000 discount to trade in vehicles which are ten years old. The scheme will be implemented next month.

Unemployment in the UK during the three months to February jumped to the highest level since 1997 as the worst recession since the World War II forcing companies to cut headcounts.

For its part, the Bank of England has cut the key interest rate to a record low of 0.5%. The central bank also embarked on an asset purchase scheme worth GBP 75 billion. This week, Andrew Sentance, an MPC member said the economy might emerge out of recession during the course of the year and into 2010.

While concluding his budget speech, Darling had stated, you can grow your way out of recession.

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