• Revised GDP figures reveal 0.6% drop to two-year low
• Business investment also down 7.1% in first quarter
Britain's fragile recovery was dealt a severe blow on Wednesday after figures revealed a slump in household spending that could severely restrict growth and knock the government's debt reduction plans off course.
A shock collapse in business investment in the first three months of the year added to the gloomy picture of a sluggish economy sliding back into recession.
Several economists said a downturn in key areas of the economy meant there was unlikely to be an interest rate rise until at least November and possibly next year. Danny Gabay of Fathom Consulting said the UK was already back in recession if exceptional items were stripped out of the Office for National Statistics' revised GDP figures.
"Were it not for the sharp decline in imports, due to some erratic items, the UK would now officially be back in recession. And indeed, as far as the domestic economy is concerned, it is already there," he said.
Household spending declined by 0.6% to a two-year low, said the ONS as it confirmed that the economy overall had been flat over the last six months, after a 0.5% contraction in the last quarter of 2010 was offset by a 0.5% rise in the first three months of this year.
Business investment fell 7.1%, partly in response to a decline in spending on executive jets, after a rush to buy private aircraft at the end of last year ahead of the VAT rise in January, but also as businesses prepared for a difficult year.
Ed Balls, Labour's shadow chancellor, said the figures confirmed that the economy had entered a more difficult phase. He blamed the deteriorating economy on the government's austerity measures, which he said had undermined consumer confidence and spending: "George Osborne now faces the prospect of the Office for Budget Responsibility's growth forecast for 2011 being downgraded a fourth time. Growth of just 1.4% this year compares to the independent OBR's forecast of 2.6% growth before George Osborne decided to cut further and faster."
However, the OECD, one of the west's leading economic thinktanks, called on the Bank of England to start raising interest rates this year to prevent inflation – currently at 4.5% – taking hold in the UK. In its twice-yearly report, the Paris-based organisation said Threadneedle Street ought to steadily increase borrowing costs over the next 18 months despite weak economic growth.
The OECD, which downgraded the UK's growth for 2011 to 1.4% and 1.8% in 2012, reiterated its support for the government's deficit-cutting strategy, but said the chancellor needed to put in place incentives for growth.
Releasing its half-yearly Economic Outlook, the OECD predicted that the UK would continue to lag behind most other leading industrial nations as it recovered from the deep downturn of 2008-09.
The sluggishness of the economy will feed through into higher unemployment, which the OECD expects to rise from 7.9% of the workforce in 2010 to 8.1% this year and 8.3% in 2012.
"Growth is projected to remain slow during 2011", the OECD said. "Public consumption and investment are set to fall significantly while household consumption is expected to remain subdued, reflecting falling real incomes and stagnant asset prices."
A Treasury spokesman said it was necessary to tread a careful line to keep the economy growing while inflation was rising and spending remained subdued.
He said the current strategy allowed the economy to rebalance away from domestic demand to exports, and to repay debts.
"These unrevised figures for growth continue to show a rebalancing of the economy, with a record contribution to growth from trade. The continued international concerns about deficits confirm that the government has set the right economic course," he said.
City economists remained gloomy about the prospects for a strong recovery.
Hetal Mehta, UK economist at Daiwa Capital Markets, said: "Most shocking is perhaps the scale of the fall in consumer spending. Following the contraction in the fourth quarter, these figures underline the significant weakness in the consumer sector.
"And given the recent comments from the Bank of England that unexpected weakness in consumer demand would mean a slower pick-up in interest rates than markets have priced in, we believe these figures reinforce our view that the majority of the monetary policy committee will continue to vote for no change in interest rates this year."
Investment spending fell by 4.4%, leaving government spending as the only pillar that was growing, by 1%. But this is unlikely to continue given the chancellor's vast programme of spending cuts.
ING economist James Knightley said: "This reflected the fact that government departments were making sure they spent their budgets ahead of the end of the fiscal year. Now we are in the new fiscal year with lower budgets we will start to see this component dragging growth lower."