Rates 'could fall to 3%' as UK recession alarm sounds

As retail giants from fashion to supermarkets hit trouble, economist says drastic action is needed

Interest rates could be slashed to a record low of just 3 per cent over the next 18 months as the UK slides towards recession.

Interest rates could be slashed to a record low of just 3 per cent over the next 18 months as the UK slides towards recession.

According to Roger Bootle, economic adviser to Deloitte and author of the accountancy firm's latest quarterly review of the UK economy, the next move for interest rates is down.

"We thought they had peaked after the last rise in August," he added. "It's been touch and go since then but the data in the last few weeks is now in accord. We're in a position now where we're going towards a very significant consumer slowdown and the economy cannot withstand that."

Mr Bootle believes a cut could come as soon as August, with further reductions leaving the cost of borrowing - currently 4.75 per cent - at 4 per cent by the end of this year and 3.5 per cent by the close of 2006. And, he warned, should conditions stiffen by more than expected in that time, "it could easily get to 3 per cent".

John Butler, economist at HSBC, agreed that rates could sink as low as 3 per cent, particularly if initial reductions failed to have the required effect. "If the consumer starts to slow and is worrying about the level of debt they have, then interest rates alone are not going to work. They would have to come down and come down hard."

The City has been rocked in recent weeks by bad news. A number of retailers have issued profit warnings as the consumer, until recently the backbone of the UK economy, has eased off spending. These stores include Wm Morrison, Boots, B&Q owner Kingfisher and discount retailer Matalan, while others are reporting tougher conditions.

Research by the British Retail Consortium and the CBI has backed up the warnings, with the former last week revealing that the total value of April sales tumbled 1.3 per cent, the worst slide for six years.

Media companies are also suffering as advertising revenues once again ease off. One media buyer said: "It's looking pretty bad. Some of our clients were already paring back spend two months ago. When companies are earning profits, they spend more on marketing, and generally, companies' profits are coming under pressure."

Radio groups GCap Media and Chrysalis, and Trinity Mirror, owner of the Daily Mirror, recently reported slower advertising revenue growth, and fears are growing that ITV's bookings are down sharply. Last week, Deutsche Bank slashed its earnings estimates for the television giant.

Nor it is just consumer-based industries that are suffering. The surging cost of oil and the strong pound have restrained manufacturing growth, with recent figures revealing that output slumped by 1.6 per cent in March - the worst monthly fall for nearly three years.

The CBI's Sir Digby Jones told The Independent on Sunday that the Bank of England must cut rates, as early as the summer if necessary, to improve conditions for British industry.

Oil dipped under $49 a barrel last week, however, providing a rare glimmer of hope for manufacturing.

But it is data out this week that economists will be watching closest. The Government issues retail sales figures for April on Thursday, and observers are expecting a slide of between 0.5 and 1 per cent.

Any worse and the Bank of England's Monetary Policy Committee, which only recently was discussing putting up rates, - will have to start considering trimming the cost of borrowing.

"One per cent or above would be a big number," said David Page, economist at Investec, "and the MPC would have to sit up and take notice."

Yet there are fears that this time round, cutting rates will not be enough. Following the last downturn in 2001, the Bank of England slashed interest rates to a low of 3.5 per cent and consumers responded by hitting the shops in their droves. Debt levels rocketed and few believe the UK economy can spend its way out of trouble again.

Mr Bootle also points out in the Deloitte review that the housing market "threatens an abrupt downward correction" and that public finances have deteriorated "dramatically". He says the apparent lack of acceleration in production growth is a "black mark" against the economy."

The good news, however, is that Mr Bootle does not believe the UK will suffer a full-blown recession, primarily because inflation remains low.