Surging economy 'will fuel rate rises

Interest rates are expected to rise to 5.5% by next summer as the Bank of England seeks to keep the buoyant economy in check, a leading economic thinktank has said.

Ernst and Young's Item Club, which uses the Treasury's own model of the economy, says in its latest quarterly study that the UK is powering ahead on the back of a booming world economy and lax monetary and fiscal policies.

The Item Club says strength is visible across the board, with companies recruiting again after two years in which public sector recruitment and construction contracts provided the only support for the labour market.

"Remarkably, the forecast shows the UK achieving full employment this winter," the organisation says.

The Item Club expects interest rates to rise to 5% by the end of the year and peak at 5.5% next summer, given the strength of the economy. Rates are currently at 4.5%, and analysts expect the Bank's monetary policy committee (MPC) to raise them again by a quarter point next month.

The latest forecast makes pleasant reading for Labour in general and Gordon Brown, the chancellor, in particular. It says the economy is surging forward "in a run timed perfectly for the May 2005 election... Manufacturing at last appears to have turned the corner. There is no obvious weakness anywhere."

The Item Club sees little prospect of a crash in house prices, which have been rising relentlessly in recent years. It said a dramatic correction was unlikely given the prosperous economy and relatively low interest rates and unemployment.

But Peter Spencer, the chief economic adviser for the thinktank, warned: "The next few years will only see a modest increase in property values, and individuals banking on house price inflation to pay for their retirement will suffer the same disappointment as those who relied on the equity market bubble of the late 1990s."

Less welcome for Mr Brown is the group's warning about high levels of public spending: unless Mr Brown raises taxes in the next budget, which seems very unlikely before an election, the chancellor will break his "golden rule" of balancing all spending (other than capital investment) over the economic cycle in 2005-06, the Item Club says.