Interest rates may not be cut until 2009

Bear Market

The UK’s economy is facing its toughest year since 1992, a gloomy new report by the Confederation of British Industry (CBI) has warned.

With the housing market continuing to fall and the cost of oil and food rising, Britain's biggest employers' group has slashed its forecast for growth in 2009 from 1.7% to 1.3% - the lowest level for 17 years.

The warning came just ahead of new statistics being released, which show the Consumer Price Index - the official measure of inflation - hit 3.3% in May, well above its 2% target. The governor of the Bank of England, Mervyn King, will now have to write to chancellor Alistair Darling to explain how the central bank intends to adjust monetary policy to tackle rising inflation. 

Adding to the misery, the CBI believes that inflation will continue to soar above the government’s 2% target – peaking at 3.8% in the third quarter of the year, and will not fall below 3% until early next year. As such, it
predicts that the Bank of England will have to wait until at least 2009 before it can even start to think about cutting interest rates.

Richard Lambert, the CBI's director general, said: "The oil price has continued to rise strongly, roughly doubling since the spring of 2007. This has squeezed household incomes and companies' profit margins, and has also made it much harder for the Bank of England to cut interest rates in the face of the economic slowdown."

Heading for recession?

The CBI warns that as consumers see their disposable income stretched further the high street will suffer too – with consumption growth slumping to just 0.7%. In addition, it also predicts that unemployment will climb by
150,000 to reach almost 1.8 million next year as the slowdown takes hold.

“However we believe that the UK will avoid a recession, in the sense of two quarters of negative growth, but it is a very prolonged period of very sluggish growth in prospect," said Ian McCafferty, the CBI's chief economic
adviser. "The credit crunch is less a short, sharp shock and more of a headwind that will remain for some time."

The gloomy message from the CBI was compounded by a recent survey by the Society of Business Economists (SBE), with over 60% of its 225 members believing that UK house prices may take more than four years to rise above their 2007 peak.

More than half of the SBE’s members also believe that house could fall by a further 20%, whilst one in five of those surveyed believe that house prices could slump by as much as 30%.

The SBE's chairman Bronwyn Curtis believes that borrowers may have to wait a long time to get their money back. "It doesn't look like we're going to see a fall, which is what we're in the middle of, and a quick bounce back,” she said. “It does look as though it's going to go on, and we'll have slow growth for some time.”

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