Gloom will hold rates down

The Bank of England is likely to keep interest rates on hold this week, as new forecasts suggest a sluggish economy and faltering tax revenues over the coming year.

The Bank's monetary policy committee announces its monthly decision at noon on Thursday. Most analysts expect it will leave its benchmark interest rate steady at 4% for the 14th month in succession.

Fresh evidence of the economy's weak state comes today, with the publication of the latest BDO business trends report - which indicates that companies will be hit by slower growth in consumer spending during 2003.

Another report, by accountancy firm Deloitte & Touche, is forecasting a £10bn gap in the chancellor, Gordon Brown's budget plans, and an increase in unemployment of 250,000 within the next two years.

The report, by economist Roger Bootle, predicts a 20% increase in house prices this year, to be followed by sharp falls in 2004 and 2005.

"Historically, such declarations in the housing market have invariably been accompanied by a full-blown recession in the overall economy," Mr Bootle warns.

"We believe that UK interest rates will only be cut once the housing market has started to falter. The drop in rates will moderate the fall and its consequences, but will not stop it."

The report predicts that the Bank will eventually cut interest rates to 3.5%.

Mr Bootle's view is at odds with more optimistic comments made by Sir Eddie George, governor of the Bank of England, last week.

Sir Eddie said he did not see "why there should be a crash in house prices". Instead, the Bank is anticipating that the rate of increase in house prices will moderate "quite sharply," according to Sir Eddie.

Mr Bootle forecasts that the downturn in house prices - a 5% fall in 2004, followed by a further 10% fall in 2005 - will feed through to lower consumer spending by 2004. This will be the first annual decrease in overall consumer expenditure since the recession of 1991.

The economy could still avoid an outright recession this time around, despite problems in the housing market and consumer spending. "Slower growth in household spending will eventually be offset by a recovery in exports and investment, as well as stronger government spending," Mr Bootle says.

The slowdown would, however, force the chancellor to increase fiscal borrowing from his budgeted deficit of £19bn to £29bn in 2004-05.

Most mainstream forecasters are expecting the UK economy to escape recession during the coming year. Few think it will grow as quickly as the Treasury's forecast of 2% to 2.5% during 2003.

The Bank's monetary policy committee meets amid conflicting reports of the strength of retail spending over the Christmas period.

In an interview, Sir Eddie suggested that the Bank's internal forecasts contained few signals for a change in current policy.

"On the basis that we are anticipating, the economy, on our central expectation, will grow close to trend, that inflation will remain close to target," the governor said.

"That is not something that implies a sharp change in interest rates in either direction."