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Wednesday, 8 August, 2001, 23:13 GMT 00:13 UK
Bank predicts slower UK growth
Bank of England
The Bank is under pressure to meet inflation targets
The British economy is slowing down, and growth will remain below average this year and next, according to the Bank of England.

In its quarterly inflation report, the Bank, which last week surprised markets with a quarter-point cut in interest rates to 5%, said annual economic growth would stabilise at about 2% early next year.

The Bank said the weaker outlook for growth, mainly based on worsening conditions in the world economy, lay behind its interest-rate cut.

But it warned that "the possibility that the slowdown in the international economy may be deeper or more prolonged remains a downside risk".


The Bank's forecast lay below the UK government's own assumptions, which still point towards annual growth of at least 2.25%.

The figure contributed to a gloomy mood on the UK stock markets, which were already depressed by a slew of poor results from technology firms in the US and elsewhere.

But since many had anticipated a softer outlook, the pound was little changed on the foreign exchange market, easing only very slightly against the dollar and the euro.

Many investors hope that a little economic gloom might make the Bank's Monetary Policy Committee (MPC) more likely to continue cutting interest rates in the future.

This hope was boosted by the Bank's forecast that inflation was likely to ease in the near future, despite rampant house prices and continued strength in the consumer market.

"Insurance policy"

The BBC's economics reporter Dharshini David said the Bank's report showed that last week's interest rate decision had not been an easy one.

"The Monetary Policy Committee members have stressed that they had to consider the strength of consumer demand and the worries that an interest rate cut might cause that to overheat," she said.

"Against that they are saying that the outlook for the global economy is not too bright at the moment.

"They were worried that we might see a further downturn there.

"And if they didn't cut interest rates now there it might be too late to keep activity on its feet if it cut them further down the line.

"So last week's interest rate cut was a bit of an insurance policy.

"It also meant they could keep inflation on its 2.5% target in two years time."

Inflation, excluding the cost of home loans was expected to slip to 2% early next year, from 2.4% at present, the Bank said.

Inflation will then edge slowly upwards towards the government-set target of 2.5%, it added.

'Two-speed' economy

The Bank remains concerned at Britain's "two-speed" economy, with service sector and consumer industries booming, and manufacturing in decline.

The decline in US demand for high-technology capital goods has had a larger-than-expected impact on production elsewhere, especially in Asia

MPC report

It is worried that sterling could fall sharply on the foreign exchange markets as a result.

"A fall in the exchange rate would raise inflationary pressures and so makes the overall risks to inflation rather more evenly balanced," it said.

But Ian Fletcher, chief economist at the British Chambers of Commerce, said the global slowdown was a greater risk to the UK's economy than rising inflation - giving the bank scope for further interest rate cuts.

"We are concerned that while business has woken up to the reality, some members of the MPC continue to set policy on the assumption that the exchange rate of sterling against the euro will soften soon.

"This has resulted in inflation undershooting target for two-and-a-half years, and evidently a shift in thinking is required," he added.

Analysts' reaction

Other analysts were divided on what the report meant for future interest rate decisions.

Richard Iley, of ABN Amro, said: "I am still inclined to think that the next move will be up in UK rates but that will take some time and not until the first half of next year."

Unless there is more unexpected bad news from the overseas economy we expect that 5% will represent the trough of UK interest rates

Philip Shaw, Investec

Mark Miler, of Morgan Stanley, said: "The fact that the bank considered the risks of overstimulating domestic demand suggests they won't move again unless there is a big deterioration in global economic prospects over the next month. "

Philip Shaw, of Investec, believes there will be no further cuts for now.

World economy

On the world economy, the MPC said it saw euro area growth remaining sluggish before recovering next year.

It said the United States should enjoy a gentle pick-up in growth towards the end of 2001, following big cuts in interest rates and reductions in personal taxes.

However, it added, "The decline in US demand for high-technology capital goods has had a larger-than-expected impact on production elsewhere, especially in Asia, and there have also been steep falls in the demand for high-technology equipment in other countries."

The BBC's Dharshini David
"There could be a bumpy ride ahead"
See also:

08 Aug 01 | Business
Property prices continue to rise
07 Aug 01 | Business
CBI: Manufacturers' woe worsens
07 Aug 01 | Business
Surprise surge in US productivity
07 Aug 01 | Business
Inflation report under scrutiny
06 Aug 01 | Business
UK manufacturing in recession
06 Aug 01 | Business
Q&A: The manufacturing recession
03 Aug 01 | Business
Gloom spreads to UK service sector
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