Fears grow of a slump in UK

A GROWING number of economists believe the British economy could be heading for a hard landing if the Bank of England decides to raise interest rates next month.

A series of reports last week showing that retail prices, average wages and retail spending were all rising faster than expected justified the surprise move to raise rates earlier this month. Now more and more analysts predict the Monetary Policy Committee will raise rates again when it next meets on 8/9 July.

The Bank of England faces a dilemma, though. After a series of rate increases in the past year, signs are appearing that the economy is starting to slow. Raising rates further to stem inflation could slam on the brakes for the wider economy.

"I think we're heading for a pretty rocky landing next year," said Michael Saunders, the UK economist at Salomon Smith Barney. "I'm predicting at least one more rate rise this year, and that would put a further squeeze on exports and a further squeeze on the consumer."

Home owners are already feeling the pain this week as three more mortgage lenders lifted their standard variable home loan rates to 8.95 per cent. This followed similar moves from two competitors.

Economists are now much more pessimistic about the outlook for rates than they were two weeks ago. A survey showed they were split down the middle over whether rates will rise again this year.

One of the 16 analysts questioned expected the bank's base lending rate - the lowest rate it charges banks for overnight loans - to go up to 8 per cent from its current 7.5 per cent. After the rate increase on 4 June, only two analysts predicted a further increase this year.

Last week, Bank of England Governor Eddie George warned that the economy was "close to overheating" and that domestic demand must slow from its growth rate of more than 4 per cent to stop inflation rising.

The problem for the Bank is that it is facing pressure to raise rates at a time when growth is beginning to slow after six years of expansion.

Unemployment claims rose in May for the first time in two years, while mortgage lending dipped, confirming that the housing market is coming off the boil after booming last year.

High interest rates in the UK have driven sterling's trade-weighted value up 27 per cent since August 1996. The strong pound is damaging manufacturers by making British goods more expensive on world markets and competing imports cheaper.

Rising rates could push the pound yet higher and plunge manufacturing into a full-blown recession that sends shock waves across the economy.

Mr George expects unemployment to rise and said he could not rule out a period of stagflation - rising inflation accompanied by higher unemployment and slowing growth - although this was "not the most likely outcome".

Copyright: IOS & Bloomberg