Robust economy 'will see rates rise to 5%'

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The Independent Online

The UK economy has started the new year with a bang with surging house prices, a revival in the corporate sector and signs the City believes Gordon Brown can hit his ambitious growth targets.

But the welter of good news means interest rates could hit 5 per cent by this time next year - an increase in borrowing costs of more than a third from current levels.

The ITEM Club, a forecaster that uses the Treasury's model, said the Chancellor had a "good chance" of meetings his predictions of growth of between 3 and 3.5 per cent both this year and in 2005.

"It is possible that the Chancellor will meet the lower end of his growth forecasts for both 2004 and 2005," said Professor Peter Spencer, its chief economic adviser.

"With a stronger economic picture, a private sector that is showing distinct signs of recovery and with demand holding up from the public sector, we now have a UK economy in a more robust state than for the last couple of years."

ITEM said stronger growth in manufacturing and services would lead to higher consumer confidence, bonus payments and house prices. Exports are forecast to surge by 5 per cent this year and 7 per cent in 2005.

"With household incomes forecast to rise 3.5 per cent in real terms this year, falling unemployment, a rise in equity markets and a property market continuing to move ahead, the UK economy is in reasonably good shape to meet any external shocks," Mr Spencer said.

However, this will force the Bank of England to raise interest rates aggressively from 3.75 per cent now to 5 per cent in a year's time, he said.

"We are moving into uncharted waters," he said. "With indebtedness and house prices reaching record levels, it is hard to know precisely what impact higher rates will have on the UK consumer."

According to two separate surveys published today, the business sector is in its healthiest state for several years, with sales and order books booming and the number of business failures falling.

Lloyds TSB Corporate's biannual survey showed firms had the fullest order books and strongest sales in six years. Almost half reported an increase in sales, while 43 per cent also enjoyed an upsurge in orders - the strongest levels since 1998.

The rebound in sales and orders translated into forecasts of higher profits and increased spending on investment and recruitment this year, it said. "All of this suggests a continuation of UK economic recovery into 2004," the report said.

Meanwhile, business failures have fallen to their lowest level in two years, the business advisers BDO Stoy Hayward reported. The number of companies going to the wall last year fell to 17,900 from 19,928 in 2002. But it warned a dip in consumer spending would push the number above 19,200 this year.

Rightmove, a property website, said estate agents raised the price of the average home for sale by £2,000 in the first full week of the new year. The first survey of the market in 2004 showed little evidence that November's rise in interest rates had dampened demand. Its figures revealed a record number of new inquiries on its website in the first 10 days of January.

Miles Shipside, Rightmove's commercial director, said: "This new year pick-up may set the tone for 2004. I wouldn't predict a return to the boom, but with this kind of early indication, I can't see a significant deterioration in the housing market this year as some commentators have been saying."

But ITEM, which is sponsored by the accountants Ernst & Young, warned that a growth rebound did not mean the Government would receive all the tax revenues it forecast in last month's pre-Budget report.

Mr Spencer said that without a significant increase in tax rates, the anticipated revenue figures were "no more than a pipe dream". He said: "Assuming he does not raise taxes in the Budget, the forecast suggests that the Chancellor's golden rule will be breached in the 2005-06 or 2006-07 [fiscal year]."