No need for interest rate rise, say economists

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There is no need for the next Chancellor of the Exchequer to raise interest rates because the strength of the pound will slow the economy down, a leading research institute says in a report published today.

The National Institute of Economic and Social Research says a tax increase is needed to hold the consumer spending boom in check, but higher interest rates are unnecessary.

It adds that excessive borrowing since 1990 has added the equivalent of 1.5p to the basic rate of income tax in higher debt interest payments. To put the public finances on a sustainable footing further tax increases - or extra spending cuts - equivalent to 2p on income tax are needed.

The prediction of a slowdown in the economy from its current pace of growth comes after new figures showing a reduced level of consumer borrowing last month after the record set in February. But growth in personal lending edged up again, and most City economists said yesterday that base rates would have to rise in May.

A separate survey by the Engineering Employers Federation showed a sharp rise in average wage settlements in March, to 4.4 per cent from 2.9 per cent. Although the figure needs to be treated with caution as there are very few pay settlements in March, this was the highest monthly average for many years. It follows recent official figures showing an upturn in underlying earnings growth.

William Waldegrave, Treasury Chief Secretary, nevertheless claimed that this was a "golden time" for the UK economy. "The recovery is continuing without evidence of over-heating," he said.

Ian Lang, President of the Board of Trade, opted for the less subtle "Britain is booming" message. "The feelgood factor is most certainly with us," he said.

By contrast, the National Institute's latest quarterly forecast puts it at the pessimistic end of the range of views about the economy this year. It has become considerably gloomier than almost all other forecasters about the likely impact of the strong pound on exports, on the assumption that the exchange rate stays at a high level.

The new forecast puts GDP growth at 2.6 per cent this year, a slowdown from the 3.0 per cent recorded in the year to the first quarter.

It predicts that manufacturing output will grow by less than 2 per cent this year, with very little rebound from last year's growth of less than 0.5 per cent. Inflation should be well within its target, according to National Institute economist Garry Young.

However, the report warns that the recovery is unbalanced, with consumer spending likely to rise by 4 per cent. "Ideally, the basic rate of income tax should go up by 2 pence immediately. But obviously whoever is going to be Chancellor is going to have to muddle through a bit longer in practice," said Mr Young.

Some City experts share the National Institute's concern about the likely impact of the strong pound. Others still believe that demand at home is growing more than enough to offset weaker exports.

Consumer credit expanded by pounds 780m in March, compared with February's record pounds 1.2bn. Total mortgage lending fell back from pounds 1.9bn to pounds 1.8bn. But the annual growth in total personal lending, covering both categories, rose to 6.9 per cent from 6.8 per cent the previous month.