Overheating fuels recession fear

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The Independent Online
The economy is overheating and the risk of a recession looms next year, a group of experts told MPs yesterday.

Two of the economists invited to give evidence to the Treasury Select Committee, meeting for the first time since the election, pinned the blame firmly on Gordon Brown for failing to tackle booming consumer demand.

Roger Bootle, chief economist at HSBC Markets, and Martin Weale, head of the independent National Institute for Economic and Social Research, criticised the Chancellor for missing the opportunity to cool the economy through raising taxes in his Budget earlier this month. This had put the burden of managing the economy on to interest rates and the pound.

"We should not be surprised if there turn out to be major errors in the Budget judgement," Mr Bootle said.

On the other hand, two other City economists, Gavyn Davies of Goldman Sachs, and Bill Martin of UBS, said the Chancellor had been right not to try to fine-tune the economy by raising taxes on consumers in the Budget earlier this month.

They argued that the tough public spending plans meant Mr Brown was already imposing a fiscal squeeze on the economy.

"There is here the makings of a public expenditure crisis which could hit the Government at the worst possible moment as the economy moves into recession," Mr Martin warned.

Three of the four experts reluctantly accepted the need for further increases in interest rates to ensure inflation stayed in its target range. But they said the Bank of England's Monetary Policy Committee should move very cautiously.

Mr Weale urged it to avoid any additional interest rate rises at all rather than drive the pound even higher.

"Enough has been done to slow the economy to just below its trend growth rate," he told the MPs.

For all the differences in their prescriptions, the four economists agreed in their diagnosis of the policy dilemma facing the Bank thanks to the combination of rapid growth in consumer spending and a strong pound.

They also warned that the narrow inflation band of 1.5 to 3.5 per cent set by the Chancellor meant there was a danger of the Bank moving interest rates too often to keep inflation on track.

Mr Davies said: "The chances of making a significant policy mistake - whether overkill or underkill - are higher now than at any other time in the 1990s."

But he judged there to be a greater danger of rising inflation than of slipping into recession, and was the only one of the four not to foresee a marked slowdown in the economy next year.

Mr Martin said the price now had to be paid for Kenneth Clarke's failure to lift interest rates earlier, and it was not obvious how to bring down the exchange rate. "Some deflation of the economy is required. It is a question of how you take your medicine," he said.

Mr Bootle, more tentatively, accepted that the scale of the consumer windfall from free building society shares meant there was a case for further action by the Bank.

Mr Weale, the non-City member of the panel, insisted the strong pound meant interest rates had gone far enough. T he economy would slow without any further action by the Bank of England, while there was a 25 per cent chance of a full-blown recession next year.