OECD warns on UK interest rates

The west's leading economic thinktank last night sharply cut its forecast for the UK this year and warned that the Bank of England might need to cut interest rates further to boost flagging growth.

According to the Organisation for Economic Cooperation and Development, based in Paris, Britain will grow by 1.9% in 2005 - barely more than half the rate predicted by the chancellor, Gordon Brown, in the budget .

And it said there was a risk that rising oil prices and the knock-on effects on global growth from Hurricane Katrina could result in a more sluggish performance by the UK economy this year.

The report from the OECD is likely to add to speculation in the City that Mr Brown will be forced to pare back his prediction of 3%-3.5% growth in 2005 when he makes his half-yearly economic forecast in the autumn pre-budget report.

A Treasury spokesman would not be drawn on whether Mr Brown would lower his forecast: "We will release our next forecasts in the pre-budget report."

He said the Treasury had a better forecasting record in recent years than independent forecasters, and that the OECD was still expecting UK growth to be stronger this year than that of the eurozone and Japan.

OECD chief economist Jean-Philippe Cotis said growth in the UK had slowed to an annualised pace of 2% in the second quarter of the year, a pace which he expected to continue to the end of the year although high oil and petrol prices could slow it further.

Britain, like France, was suffering from a fall in domestic demand. "There has been a sharp slowdown but it is not catastrophic. It remains to be seen what impact rising oil prices will have, but the Bank of England may want to relax monetary policy further," he said.

Petrol prices have been rising for several months, but have jumped sharply since Katrina struck a week ago. Economists fear this could further slow consumer spending and dent confidence among consumers and businesses.

The Bank made its first interest rate cut in two years last month, taking base rates down by a quarter of a percent to 4.5%. But it has signalled a reluctance to cut them again soon unless the economy unexpectedly deteriorates.

Mr Cotis said core inflation, which strips out volatile elements such as oil and food prices, had picked up in Britain. He also said UK house prices, as in many other countries, were over-inflated, but was encouraged that the housing market seemed to have stabilised this year rather than falling sharply.

He said it was too early to gauge accurately the impact of higher oil prices and Katrina on the world economy.