UK economy is 'skating on thin ice', says report

A leading economics think-tank today warned that the economy is "skating on thin ice" because of excessive household debt.

The respected Ernst & Young ITEM Club, which uses the same economic model as the Treasury, said the economy was running "at full tilt", thanks to the booming business sector, particularly services. But although Gordon Brown appears to be leaving No 11 on a high, the strong economic performance is built on shaky foundations. It said the current benign macroeconomic environment had made both individuals and firms overly relaxed about risk, inflating asset values and transactions and boosting borrowing and spending.

"Many people are following the Chancellor's lead and are borrowing to finance consumption," said Peter Spencer, the ITEM Club's chief economic adviser.

"The UK's current deficit has reached 3.5 per cent of GDP which suggests that as a country we are close to the edge. Ultimately, we are all skating - not to say wobbling - on thin ice. There's a danger that we are slithering into complacency."

Britain's consumer debt mountain has topped £1.3 trillion, raising fears that thousands of households will be left with debts they cannot afford to repay if interest rates are jacked up. Shock figures last week showing inflation had jumped to a 10-year high of 3.1 per cent, prompted some analysts to predict that rates might have to rise from their current 5.25 per cent to 6 per cent.

Professor Spencer, however, believes that one more hike, to 5.5 per cent in May, will be sufficient to bring inflation back to its 2 per cent target.

The report also highlights the huge black hole that has opened up in the public finances, despite the strength of the economy and buoyant tax revenues. Mr Brown upped his borrowing forecasts yet again in last month's Budget, and is now expecting the Treasury's coffers will be in the red to the tune of £34bn in the 2007-8 financial year.

Professor Spencer said: "The bottom line is that we are all living beyond our means. In the short-term, Mr Brown has resorted to borrowing for consumption. If the Chancellor is forced to borrow so much when the economy's so sweet, what will happen when it turns sour?"

Despite the grim warnings, the ITEM Club predicts the economy will expand by a healthy 2.9 per cent this year, in line with the Chancellor's 2.75 to 3.25 per cent forecast. Growth is expected to slow slightly to 2.7 per cent in 2008.