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Wednesday, 4 July, 2001, 15:05 GMT 16:05 UK
Bank weighs two-speed economy
Mansion House, London.
Worries about the pound at Mansion House
By the BBC's economics reporter Dharshini David

As the Bank of England begins its consideration of interest rates this week, the UK economy appears to be in good shape.

At a time when the global economy is faltering, the UK appears to be still strong - at least on the face of it.

The economy has been growing for over eight years - the longest continuous period since the war.

Employment is at record level, inflation is low and the cost of borrowing is close to its lowest for many years.

And certainly consumer spending, which accounts for about a half of economic activity is strong.

Consumer spending
Retail sales are still rising

Buoyed by rising house prices, high employment , low interest rates and higher public spending, consumers are in an upbeat mood.

Equity markets may have had a rocky few months, but consumers' fortunes in the UK are effected far more by the value of their homes than that of any shares they may hold.

Increased spending

That means they are borrowing and spending more.

Retail sales rose by 6.4% over the last year - the fastest growth for four years.

Over most of the last decade, robust household spending has been the driving force behind growth in the economy as a whole.

Up until now, bargain hungry consumers and fierce competition between retailers have kept inflation low despite strong demand.

But now, there are signs that price pressures are creeping up.

Manufacturing slowdown

But the impressive statistics for the economy as a whole mask some increasingly weak spots, with some sectors already feeling the pinch from the global economic slowdown.

Perhaps the most obviously hit has been the export-dependent manufacturing sector.

Industry has already suffered over the last few years, largely due to sterling's strength against the euro, which has pushed export prices up - and caused the sector to fall briefly into recession in the late 1990s.

And no sooner had manufacturing got back on its feet than it appears to be on the brink of another slump.

Another technical recession - two or more quarters of falling output - looks likely within the next few months.

Global market pressure

Weaker global demand also means faltering exports - and a widening trade in goods deficit with the rest of the world.

But its not just exporters who have been hit by the US economic slowdown.

In an increasingly global market, the number of profit warnings issued by UK businesses in all sectors has risen.

UK companies have invested heavily in the US - close to 3% of the UK's national income comes from the income earned on these investment.

And equally, US companies have a heavy presence in the UK - and are likely to be trimming not only jobs, but also employment.

Manufacturing factory worker
Manufacturing - weak spot in the economy

The turmoil in equity markets has also taken its toll on the financial sector.

Certainly, there is very clear evidence of this two speed economy, but the gulf between the performances of the manufacturing and other sectors of the economy has been evident for the last five years or so.

And most experts think the strength of the domestic economy will keep the UK as a whole well away from a recession.

Reason for concern?

There is concern in the sense that this divergent economy poses a problem for the policy makers, namely the Monetary Policy Committee at the Bank of England.

Speaking at the annual Mansion House dinner in June, the Bank's Governor Sir Edward George admitted the Bank of England had cut interest rates earlier this year to bolster consumer demand and insulate the UK from the global slowdown - at the expense of worsening the imbalance in the economy.

But he said this could spell trouble, if the value of the pound suddenly fell, perhaps due to speculation over euro entry, which could risk driving inflation up.

Edward warned "the imbalance can not continue to grow indefinitely, at some point, the elastic is going to break - quite possibly through a sharp exchange rate adjustment. And at that point, having deliberately stimulated domestic demand we would need to rein it back, but we could then find its momentum hard to stop."

In other words, the two speed economy poses a dilemma for the rate setters.

Cut the cost of borrowing further to help those parts of the economy which are being hurt by the global slowdown - and consumer demand could expand too fast.

This could risk inflation rising which would necessitate, ultimately, a sharp increase in rates.

But alternatively, not cutting rates any further (and raising them too soon) might risk the UK becoming sucked into the global economic slowdown.

With domestic spending still sturdy most experts believe interest rates will be left on hold for at least the next couple of months.

But as the performances of the key sectors of the economy diverge, so too are opinions on the direction interest rates will take after this point.

While many independent economists believe the cost of borrowing could have further to fall, a growing number are forecasting that the next move in rates could be up.

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