Treasury foresees base rate cuts to boost growth

Economists forecast lower interest rates later in year; City predicts economic growth of 2.1%

The Bank of England will be forced to cut interest rates to shore up the slowing economy this year, most City economists believe.

A slim majority of finance houses in the Square Mile expected rates to come down this year, with a couple forecasting they would fall back to their 50-year low of 3.5 per cent.

Fourteen out of 24 economists surveyed by the Treasury predicted that rates would fall from their current 4.5 per cent to between 4.25 and 3.5 per cent. Two saw them stable at 4.5 per cent while eight predicted at least one more rise. A rate cut was put firmly on the agenda last month after Stephen Nickell, one of the nine members of the Bank of England's Monetary Police Committee, voted for a reduction at December's meeting.

The average City forecast is for rates to end the year at 4.25 per cent as the economy grows by 2.1 per cent, at the lower end of the Treasury's forecast range of 2 to 2.5 per cent.

Deutsche Bank, which expects rates to be cut to 4.25 per cent, said that 2006 would be categorised by "subdued growth and lower inflation". George Buckley, its UK economist, said: "The Bank will cut rates again as the consumer fails to recover quickly, GDP growth remains below trend and inflation eases further."

However, Mr Buckley said he had abandoned his call for an early new year rate cut in the light of signs of stronger Christmas retail sales and the upturn in the health of the housing market. "The probability seems to be rising that the MPC delays any rates cuts until later in the year [and] after 50 basis points of cuts in 2006 we tentatively expect unchanged rates during 2007."

Bank of America has pencilled in growth of 2 per cent, up from 2005's 1.7 per cent, as export growth offsets weak domestic demand. "The [current] rate is still relatively high at 4.5 per cent," said Lorenzo Codogno, its co-head of European economics. "Following a first cut in August and a long pause to better assess the economic situation, we expect the Bank to shave rates further to 4 per cent by year-end."

He said that the short-term outlook would be overshadowed by more structural issues such as poor productivity growth, a tailing off in immigration growth and perceptions of rising tax and regulation harming the UK as an investment destination.

"Whether the structural advantage over other European countries can be maintained remains uncertain," he said. "We are concerned that potential growth in the UK may be diminishing."

Commerzbank, one of the institutions forecasting no change in rates during 2006 - although not in the Treasury survey - said there were signs that the economy was picking up speed again. "The period of correction on the housing market is coming to an end," said Gerard Muller, its senior economists, who forecasts 2.3 per cent growth. "New mortgages are rising rapidly and house prices too have probably risen a little in the recent past."

At the top end of the scale are houses such as Barclays Capital and Lombard Street Research that expect the economy to surpass the Treasury's forecast. Both predicted growth at 2.7 per cent, while a third analyst, Bridgewell, suggested growth could even reach 2.8 per cent.

Bridgewell, which a reputation for a bullish outlook, also tops the interest table with a forecast for a half-point rise to 5 per cent over the course of the year. Richard Jeffrey, its chief economist, admitted that its 2.5 per cent forecast for last year had proved over-optimistic but said he was confident of above-trend growth in 2006.

"We are predicting stronger growth in household spending than is widely anticipated," Mr Jeffrey said.

He added that factors that had hit consumers last year such as increases in interest rates, inflation and the tax take, would "fade and possible reverse". He has pencilled in a 3 per cent rise in consumer spending compared with a consensus of 1.8 per cent.

Mr Jeffrey added: "Any policy changes in 2006 - and we believe rates will rise during the second half - are unlikely to impact behaviour until 2007."