Aug. 22 (Bloomberg) -- The U.K. economy stagnated unexpectedly in the second quarter, ending the nation's longest stretch of economic growth in more than a century.

Gross domestic product was unchanged from the previous quarter, the Office for National Statistics said, compared with a previous estimate for growth of 0.2 percent. Economists had expected a 0.1 percent expansion, according to the median estimate of 34 economists. Growth was 1.4 percent from a year earlier, the weakest since 1992.

The report, which showed the biggest drop in investment in 23 years, adds pressure on the Bank of England to set aside inflation concerns and cut interest rates. It also worsens Prime Minister Gordon Brown's struggle to salvage his reputation for economic competence. The pound fell more than 1 percent against the dollar and weakened against the euro.

``There is still worse to come,'' Ross Walker, an economist at Royal Bank of Scotland Group Plc in London, said in a Bloomberg Television interview. ``We may have to wait until early 2009 before we get the first rate cut because the inflation situation still looks pretty forbidding.''

Business investment dropped 5.3 percent while household spending declined for the first time since 2005, falling 0.1 percent.

Breakdown of Weakness

Industrial production, which includes manufacturing as well as utilities and oil and gas extraction, has now contracted for two consecutive quarters. Construction also shrank. Service industries, which range from banks to airlines, grew at the slowest rate since 1995.

The U.K. currency declined at least 1.3 percent to $1.8526 against its U.S. counterpart. It has already posted its longest run of declines in at least 37 years against the dollar this month. Against the euro, the pound weakened as much as 0.7 percent to 79.86 pence from 79.32 yesterday.

The implied rate on the December futures contract fell 2 basis points to 5.72 percent. The contract settles to the three- month London interbank offered rate for the pound, which was set at 5.76 percent today.

Europe's second-largest economy emerged from its last recession in 1991 and then shrank for a single quarter in the three months ending in June 1992. Britain's pace of expansion from a year ago compares with 1 percent in Japan, 1.8 percent in the U.S., and 1.5 percent in the nations using the euro.

Political Fallout

Today's report is a blow to Brown, who is battling to revive his government's popularity with voters and quell talk of challenges to his authority from within the ruling Labour Party. Opposition lawmaker held up the figures as evidence that Brown's ability to manage the economy has collapsed.

``Brown's bubble has burst,'' said George Osborne, a Conservative member of Parliament who speaks on finance. ``Millions of people are paying an unfair price for Labour's economic incompetence and the fact the prime minister didn't put money aside during the good times to prepare for a rainy day.''

Vince Cable, a Liberal Democrat lawmaker who speaks on economic policy, said the figures show ``the full extent of the self-delusion which led ministers to believe that everything was well with the British economy.''

Brown said on Aug. 20 that the government will announce measures to revive the economy next month. He is attending the Olympic Games in Beijing today.

``The U.K., like other economies, is seeing the consequences of globally high commodity prices, as well as the uncertainty in the credit markets,'' a Treasury spokesman said in an e-mailed statement. ``The government's priority is to guide Britain through these challenging times.''

Credit Crunch

The economy faltered after banks choked off credit following the collapse of the subprime mortgage market in the U.S. Goldman Sachs Group Inc. economists said yesterday tighter credit markets will push half of the world economy into a recession.

``The bank needs to prevent a fairly shallow recession from getting worse,'' said Stewart Robertson, an economist at Morley Fund Management in London, said before the report was published. ``They need to cut rates this year.''

Banks worldwide have shed more than 100,000 jobs and suffered more than $500 billion in writedowns and credit losses after the collapse of the subprime mortgage market in the U.S. last year. A report yesterday by recruitment firm Morgan McKinley showed London job openings in the financial-services industry fell 16 percent in July from a year earlier.

Living Costs

While living costs are rising in Britain, the value of homes is plummeting as banks withhold funding for mortgages. Residential property prices fell 8.8 percent in July from a year earlier, the most in at least a quarter century, mortgage lender HBOS Plc said on Aug. 7.

The bank's inflation forecasts show the consumer price index will fall below the 2 percent target in two years if interest rates remain unchanged. The nine members of the central bank's Monetary Policy Committee split three ways on how to steer interest rates this month, minutes of the meeting showed.

David Blanchflower voted for a quarter point cut while Timothy Besley wanted an increase of the same amount. The majority of the committee including King opted for no change.

The simultaneous risks to inflation and growth mean that the bank is preparing to cut rates but will wait to do so until next year, said George Buckley, an economist at Deutsche Bank AG in London.

Yesterday, he said he now expects four quarter-point rate reductions next year, starting in February. Previously he was counting on two.

``The bank signaled that inflation is going to stay high for quite some time,'' he said. ``They might want to see evidence that it has come down or is peaking before they opt for a rate cut.''

To contact the reporter on this story: Jennifer Ryan in London at Jryan13@bloomberg.net

Last Updated: August 22, 2008 11:43 EDT