National Institute calls for urgent rate cut to stave off UK recession

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The Bank of England should have cut interest rates two weeks ago and must certainly lower them next month, one of the UK's leading independent think tanks said yesterday.

The National Institute of Economic and Social Research said it disagreed with the Bank's analysis of the economy and also disputed the Government's optimistic forecast for growth this year. In its quarterly economic review it said UK growth would fall to 2.1 per cent this year from 2000's 3.0 per cent.

This is below the mid-range forecast of 2.5 per cent which Gordon Brown, the Chancellor of the Exchequer, confirmed at the meeting of G7 finance ministers in Rome last weekend.

"Any lingering hopes that the economy might be immune to the global slowdown have been dispelled by the recent plunge in manufacturing output," said Martin Weale, the institute's director. "A further cut in interest rates in August is needed ... to protect the economy from the impact of the global slowdown."

Mr Weale said a key factor in the gloomy outlook was a 2 per cent fall in manufacturing output between March and May which, if sustained for the rest of the year, would virtually wipe out growth for the whole economy. Asked whether he would have joined Sushil Wadhwani, who voted for a rate cut two weeks ago, he said: "Seeing the manufacturing data, if I had had time to absorb them and put them in the context of declining world output I would have voted to cut rates." He said that on balance there was less risk in cutting rates too far than in leaving them on hold for too long. "Further weakening of the economy would be more damaging than an unnecessary rate cut."

The National Institute challenged the reasoning of the Monetary Policy Committee that led it to keep rates on hold at 5.25 per cent by eight votes to one earlier this month. It said that contrary to popular opinion the consumer economy was not enjoying a boom. While retail sales were robust, consumption growth was below its recent trend and consumers had only recently turned optimistic.

The report included separate analysis of the housing market, which recent data has shown to be growing strongly. It found houses were, on average, undervalued. "Because interest rates are low, prices can rise a long way before they start to appear expensive by historical experience," Mr Weale said. "Considerably higher house prices are likely to be sustainable unless interest rates increase sharply, which no one is suggesting," he added.

The National Institute said even GDP growth of 2.1 per cent might be optimistic and that there were risks on the downside. It said it was forecasting a pick-up in world trade, which might not materialise. "If it did not happen the outlook would be much more gloomy," Mr Weale said. "I am reminded of the contraction in trade between 1930 and 1932."

There was evidence yesterday that consumer demand might be slowing. Banks made new loans at the slowest pace in four months, the Bank of England said. The British Bankers' Association said new consumer loans fell 11 per cent in June to £820m. Credit card borrowing rose £101m, down from May's increase of £249m. "There may be signs in these figures of personal borrowing easing," said BBA chief executive, Ian Mullen.

A surge in public spending last month left public finances with a larger than expected deficit. Public sector net borrowing saw a deficit of £3.5bn, significantly higher than the £1.0bn deficit in June last year.