Rates to 'hit 7.5%' unless Budget intervenes

Interest rates will peak at 7.5 per cent - the same as the last economic cycle - unless the Chancellor uses the Budget to control a booming economy, a business research unit said today.

The UK economy is forecast to grow 3.3 per cent this year compared with 2.0 per cent in 1999, the Centre for Economics and Business Research said. It said rates would climb to 6.75 per cent next year and 7.5 per cent in 2002 as inflation picked up.

The centre said that it has revised up its forecast for growth in 2000 from 2.6 per cent because the post-millennium hangover had proved less severe than it had assumed.

"Indeed," said CEBR chief executive Douglas McWilliams, "the real growth in the economy is likely to be rather more than the official statistics suggest, since the e-business sector is likely only to be partially measured by the statistics."

The CEBR said that its positive outlook was based on expectations that the consumer boom would be fuelled further by rising real incomes as wages continue to grow, unemployment falls and from windfalls from demutualisations.

The centre has pencilled in a 5 per cent rise in average earnings and a fall in the claimant count to 1.13 million, which it said would hit a trough of 950,000 in 2001.

Mr McWilliams said that although there had been an economic slowdown in the early months of this year it had been much less than expected. "Rapid growth is likely to resume before the summer," he said.

Solomon Peters, a co-author of the report, said that the Chancellor, Gordon Brown, should ideally use the Budget tomorrow to "take some steam out of the economy and so limit the likely rises in interest rates".

"But it will be politically difficult for him to do much here and so we suspect that rates will have to take the strain," he said.

The CEBR predicted that the Government's preferred measure of inflation, which excludes mortgage payments, would fall to an average of 1.9 per cent this year. Although it will rise back to 2.3 per cent next year and in 2002, it will still be below the target of 2.5 per cent.

But another economist, Richard Jeffrey at Charterhouse Securities, warned that the Government should "bank" the windfall offered by current low inflation by keeping a tight control on public finances in the face of demands for a loose fiscal stance.

He said inflation had been suppressed by the strength of the pound and the level of competition on the high street. But he said domestic services inflation was current running at 5.6 per cent.

"Rather than enshrine the windfall of sterling strength in the overall price level, the authorities have transferred the benefit to the household sector by allowing higher income growth," he said. "Good fortune only remains if it is not squandered. It is vital that Mr Brown recognises this in his Budget."