The Organisation for Economic Cooperation and Development (OECD) says in its twice yearly forecast that the world economy will grow by 3.5% in first two years of the new millennium, after a better than expected growth rate of 3% this year.

The 29 richer countries which make up the OECD will see growth of 2.9% next year, and 2.6% in 2001.

That slower rate of growth will mainly be caused by a sharp slowdown in the US. The OECD believes that the current US boom - with growth rates near 4% - is unsustainable, and said it expected the US central bank, the Federal Reserve, to raise interest rates to 6.5% by 2002.

The Fed is meeting on Tuesday in Washington, and will be considering whether to increase rates from their current level of 5.25%.

Pressures on the US economy include a tight labour market, high private sector borrowing, and a growing current account deficit, according to the OECD.

It warned that there could be further shocks to the US economy if inflation shot up, which could upset US financial markets, causing a fall in shares.

"Such a change would accentuate inflationary pressures by weakening the exchange rate, driving long-term interest rates up, and share prices down," the report said.

Europe recovers

While growth in the US may be slowing down, the OECD expects both Japan and Europe to show signs of recovery.

The European Union is expected to grow by 2.8% in the next two years, compared to 2.1% this year. The recovery will be led by Germany, which is expected to recover from this year's poor performance of 1.3% - down from a previous projection of 1.7% - to 2.3% in 2000 and 2.5% in 2001.

But given the spare capacity within the European economies, including the high level of unemployment, the OECD does not expect the European Central Bank to have to raise interest rates again soon.

Good news for Britain

The European recovery will be good news for the UK, since Europe is the UK's biggest export market.

The OECD says that the UK will grow by 1.7% this year, and 2.7% next year, broadly in line with the government's forecast, before falling to 2.3% in 2001.

Is says that "consumer confidence is strong and export market prospects have improved significantly".

But it warns that with little slack in the economy, further rises in interest rates might be necessary if inflation begins to accelerate.

But "enhanced central bank credibility coupled with a broadly neutral fiscal stance should limit the magnitude of the required monetary tightening," it said.

In layman's terms, if the government doesn't spend too much money, and people believe that the monetary policy committee of the Bank of the England will keep a tight lid on inflation, then interest rates may not have to rise very much.

Uncertainty in Japan

The biggest uncertainty for the OECD concerns the situation in Japan, the world's second biggest economy.

The OECD says that Japan will recover from its recession, which saw output drop by 2.8% in 1998, to growth of 1.4% this year, better than the zero growth forecast in May.

But Japan will still only be growing by 1.4% in 2000, and 1.2% in 2001.

The OECD warns that even that recovery could be jeopardised by the strong yen, which has already gained 12% this year.

"Further pronounced yen appreciation could derail the Japanese recovery with consequences for other countries in the region," the report said.

Last week the Japanese government launched its ninth economic stimulus package, but the OECD warned that although even more recovery packages might be necessary, there was a medium term danger that government debt will become too large to be sustainable.