Slowdown in recovery 'will halt rates rise'

ECONOMIC recovery is set to slow sharply next year, limiting the need for interest rate increases, according to a study carried out using the computer model of the economy which Treasury officials use to advise the Chancellor.

The independent Ernst & Young Item Club predicts the economy will grow by 2.7 per cent next year and 2.5 per cent in 1996, following growth of 3.7 per cent in 1994. Item believes high-street spending will be constrained by the delayed impact of tax increases, slow job creation and the impact on the housing market of higher base rates.

'While the Treasury and the Bank of England are right to be concerned with the risk that strong growth over the next 12 months could lead to inflationary pressures by 1996, I believe they are underestimating the likelihood of the economy slowing during 1995 of its own accord,' said Paul Droop, Item's chief economist.

Item expects inflation to increase slowly, but not to threaten the 1 to 4 per cent target for underlying inflation - which excludes mortgage interest payments - next year. This means that base rates should not need to rise above 7 per cent, from their current 5.75 per cent. This is a less dramatic increase than that expected in the sterling futures market.

The strong impetus to growth from export markets is expected to peter out during the rest of this year, while companies restrain their investment because of fears about the strength of recovery and their desire to pay off debt. Companies are expected to continue finding great difficulty in passing on pressures on their costs to consumers in the form of higher prices.

Item also predicted that government borrowing would continue to fall more rapidly than the Treasury's published forecasts suggested. It expects cuts of pounds 3bn to pounds 3.5bn in personal taxes in 1996, timed for maximum pre-election impact.

Fears of a slowing recovery receive backing from the Finance and Leasing Association today. It reports that consumer credit grew less rapidly than in previous months in the run-up to September's base rate increase.

'Consumers have not forgotten the last set of interest rate rises,' said David Hardisty, the FLA's chairman. 'The Government underestimated this fear factor and put up rates when confidence was still too shaky.'

Patrick Minford, professor of economics at Liverpool University and one of the Chancellor's 'six wise men', took a more upbeat view of Britain's economic prospects. In his October forecast, he said inflation was being subdued by low-cost competitors overseas. He recommended a pounds 3bn tax cut next month to help to offset the tax rises announced last year, with a further pounds 6bn of tax cuts next year.

Professor Minford forecast growth of 3.3 per cent this year, followed by 3.1 per cent in 1995 and 3.6 per cent in 1996. He expects inflation to remain below 3 per cent and unemployment to fall below 1 million by 1998.