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Q3 GDP beats forecasts but risks ahead

LONDON (Reuters) - The economy grew twice as fast as expected in the third quarter and ratings agency Standard and Poor’s lifted the threat of a credit downgrade, a boost for a government under fire over steep spending cuts.

But the risk of a sharp slowdown in the first half of 2011 remains, with strong headwinds likely to come from tax rises, a patchy recovery in Britain’s main trading partners and cuts which may cost half a million jobs in the public sector.

The Office for National Statistics said the economy grew 0.8 percent between July and September, down from a nine-year high of 1.2 percent in the second quarter but twice the 0.4 percent most economists had expected.

Sterling jumped and gilts hit a one-month low as investors reckoned the combination of above-trend growth and above-target inflation meant the Bank of England would struggle to justify an expansion of its “quantitative easing” to support the economy.

Speculation the central bank might pump more money into the economy gathered pace this month after one policymaker, Adam Posen, broke ranks to vote for additional easing. However, Andrew Sentance, the committee’s most hawkish member, lost no time in reiterating his belief that interest rates should now start to rise -- albeit gradually.

Economists said the data was likely to make the Bank keep policy unchanged for longer.

“For the Bank of England, the GDP strength probably minimises for the time being the risk of others joining Adam Posen in voting for another round of QE,” said George Buckley at Deutsche Bank.

GOVERNMENT PLEASED

In annual terms, the economy grew by 2.8 percent in the third quarter, the fastest rate in three years and up from 1.7 percent in the previous quarter. The Bank had forecast growth of around 2.4 percent in August.

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Less than two hours after the data, ratings agency S&P raised the outlook on the country’s triple-A rating to “stable” from “negative,” citing the government’s commitment to see through its ambitious austerity programme.

British finance minister George Osborne described the GDP reading and the move from S&P as “a big vote of confidence in the UK and a vote of confidence in the coalition’s economic policies.”

Taking both the second and third quarters together, the economy enjoyed its strongest six-month growth spurt since the first half of 2000.

However, this momentum is not expected to last. Cuts to public-sector jobs and spending start in earnest next year, and a rise in value-added tax and reductions in some benefits will take money out of consumers’ pockets.

Tight credit from banks adds to the difficulties the private sector will face in replacing public sector activity.

“The government will no doubt take this as a sign that the private sector can fill the gap created by public sector cuts, but with consumer confidence, hiring intentions surveys and housing activity data all softening we remain cautious,” said James Knightley, an economist at Dutch bank ING.

CONSTRUCTION BOOST TO FADE

A quarter of the third-quarter expansion was due to construction, enjoying a second quarter of strong growth following disruption from an unusually icy winter. Construction output expanded by 4.0 percent on the quarter and 11.0 percent on the year, its best annual performance since 1988.

A man speaks on a mobile phone next to columns outside the Bank of England, in the City of London, August 17, 2010. REUTERS/Andrew Winning

Commentators were united, however, in expecting the boost to be short-lived. Public works contracts have been one of the first casualties of the austerity drive and house prices have weakened markedly over the summer, denting housebuilders’ enthusiasm for new projects.

“Looking ahead, with the cuts already set out in the comprehensive spending review, contractors face a difficult period ahead and optimism in the civil engineering sector is not high for 2011,” said the Civil Engineering Contractors’ Association’s head of industry affairs, Alasdair Reisner.

Services growth held steady at 0.6 percent on the quarter but industrial output growth slowed to 0.6 percent from 1.0 percent in the previous quarter.

The EEF, which represents manufacturers, said the recovery appeared steadier than that after past recessions, but that future growth could not be guaranteed.

“Below the headline number we are still only seeing tentative signs of the economic rebalancing the UK needs,” said EEF senior economist Jeegar Kakkad. “The rising risk of a currency war, coupled with cautious consumers at home, could still derail recovery.”

Additional reporting by Lorraine Turner and Fiona Shaikh, editing by Patrick Graham

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