Economy on knife-edge admits Government

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A SENIOR Cabinet minister warned last night that the economy was on a "knife edge", in spite of the lowest unemployment figures for 18 years and hopes that interest rates could be pegged for a year.

David Blunkett, the Secretary of State for Education and Employment, abandoned the optimism he had expressed earlier in the day to urge all sides of industry - unions and bosses - to pull together to see Britain through the economic difficulties ahead. His warning came after the Bank of England cast a gloomy shadow over otherwise hopeful economic indicators.

"We have a knife-edge situation in which all of us have a part to play, in which blaming other people simply won't help, and where the complex impact of the global economy has its impact on everything we do," he said on Channel Four News.

The Treasury Chief Secretary, Stephen Byers, had earlier delivered an upbeat message with the latest unemployment figures showing the jobless total fell by 26,000 in July to 1.3 million, the lowest total for 18 years. The rate of average earnings growth also fell for the first time this year, to a headline rate of 5 per cent.

Mr Blunkett's later remarks sparked Conservative accusations of "muddle and confusion" at the heart of the Government over the economy. Francis Maude, the Tory spokesman on Treasury affairs, said: "He is way off message, but David Blunkett is absolutely right that the economy is on a knife edge and this government put it there."

But Mr Blunkett's tacit admission that the economy is facing a serious risk of recession will also be seen as an attempt to placate unions who are growing increasingly restive over the Chancellor's strategy for dealing with inflation as the priority. Some union leaders expressed anger yesterday that a Labour government was not doing more to help the manufacturing industry, which is continuing to show a downturn, in spite of a boom in the service sector.

The Bank of England warned that inflation was due to rise and said that the unemployment level was probably below its "natural rate" - suggesting that jobless totals would have to rise to help keep inflation down.

At the same time, City economists forecast that worries about inflation would prompt the Bank to keep interest rates on hold until well into next year, despite pleas from industry leaders and union bosses for a rate cut.

The warning by Mervyn King, deputy governor of the Bank, provoked angry responses from both Labour MPs and the unions.

Labour MPs are also preparing a campaign in the run-up to the Labour party conference to urge the Chancellor to change the terms of reference for the independent monetary committee of the Bank of England.

"There is growing anxiety because of these predictions of increasing unemployment," said Andrew Mackinlay, the Labour MP for Thurrock.

The Bank said underlying inflation would rise above the 2.5 per cent target next year, partly due to recent strong growth in earnings and partly due to the prospect of a National Minimum Wage. The Bank also cut its forecasts for economic growth and said there was now a one-in-eight chance of a recession next year.

Mr King refused to rule out another hike in interest rates, saying that to do so would be "dishonest".

The consensus in the City is now that rates have peaked, but few think rates will begin to come down until well into next year. Ken Wattret, of investment bank Paribas, said: "Talk of a cut in rate by year-end looks premature."