Sept. 10 (Bloomberg) -- Turkey's economy lost momentum in the three months through July, expanding at its slowest pace since the first quarter of 2002 as high interest rates squeezed consumer spending.

Economic growth slowed to 3.9 percent from a revised 6.9 percent in the previous three months, the state statistics office in Ankara said on its Web site today.

The central bank raised interest rates 4.25 percentage points to 17.5 percent, the highest level in Europe, last year as it struggled to try and bring inflation down to a 4 percent target agreed with the International Monetary Fund. Those increases ``successfully'' curbed domestic demand and the bank is considering cutting rates in the last quarter, central bank Governor Durmus Yilmaz said on Sept 6.

``Consumer demand was low, which confirms the central bank's expectation of a slowdown,'' said Haluk Burumcekci, chief economist at Fortis Bank AS in Istanbul. ``Today's figures are ``supportive of a central bank cut in interest rates.''

The lira strengthened to 1.3030 to the dollar at 11:30 a.m. local time from 1.3068 before the figures were released.

Burumcekci expects the central bank to cut its benchmark rate by 25 basis points in October and to reduce it by a total of 100 points before the end of the year.

Falling Inflation

Inflation has fallen from a high of 70 percent at the start of 2002 to a 37-year low of 6.9 percent in July.

Record levels of exports and government spending ahead of July elections helped sustain the economy's 22nd consecutive quarter of growth. While private consumption spending contracted an annual 0.3 percent in the quarter, exports grew 12.7 percent. The economy this quarter had been expected to increase by 4 percent, according to the median estimate of 12 economists surveyed by Bloomberg.

Exports have expanded an annual average of 24 percent every month this year. They rose to a record $9.1 billion in May as European economies, the destination of almost 60 percent of Turkish sales abroad, drew in products such as cars and refrigerators.

Growth in the three months through June was also helped by government spending on water supplies and roads in the run-up to elections. Non-interest government spending increased 26 percent in the first six months of the year from the same period in 2006.

Public Construction

Public sector construction leaped 47 percent in the second quarter from the year before, the statistics office said today.

``Public spending has increased through projects that were accelerated or carried out ahead of plan,'' Burumcekci said. ``That's helping to support growth before the elections, although that may turn negative in the second half if they cut spending to compensate.''

The ruling Justice and Development Party won a second five- year term in the July 22 balloting. The party promises to promote growth and employment by lowering taxes and encouraging foreign investment in the European Union membership candidate.

``We expect domestic demand to pick-up in the second half of the year as disappearing political tensions lead to stronger consumer and business confidence,'' Inan Demir, economist for Finansbank AS in Istanbul, wrote in a note to investors. ``We maintain our 2007 growth estimate at 5.2 percent.''

The central bank expects growth of about 5 percent this year.

Weaker domestic demand has slowed industrial production, which increased an average 3 percent in the three months through June compared with 8.5 percent in the previous quarter. Output rose 3.5 percent in July, the statistics office said today.

Sales of passenger cars contracted 31 percent in the first six months of the year from the same period in 2006 as the higher lending costs curbed demand, according to the automobile distributors' association.

Second quarter earnings at Ford Otomotiv Sanayi AS, the Turkish unit of Ford Motor Co., fell 6.9 percent from a year earlier as domestic sales declined.

To contact the reporter on this story: Steve Bryant in Ankara at Sbryant5@bloomberg.net.

Last Updated: September 10, 2007 06:26 EDT