Economy 'facing painful slowdown'

The weakening pound is benefiting exporters.

The UK economy is set for a "rapid, painful adjustment" over the next two years, according to an influential economic forecasting group.

Growth will fall from 3.1% in 2007 to 1.8% this year and 1.5% in 2009 unless the government acts decisively predicted Ernst and Young's Item Club .

Employment will hold steady while manufacturing will reap the benefit of the strong pound, the report said.

But the outlook for the housing market and High Street is "bleak", it added.

House prices will fall by 10% in the next two years, while the number of people moving home will shrink by 40% , the report said.

And with consumers less able to borrow money because of lenders' stricter loan criteria, the growth in consumer spending will slow from 3% last year to 1% in 2008 and 2009, it predicted.

"Although the UK economy has remained relatively buoyant so far this year, our reliance upon international banking markets means it is only a matter of time before it slows," said Peter Spencer, the Item club's chief economic advisor.

"This is going to be a rapid, painful adjustment and it will be a rough ride for a substantial proportion of the population. We are facing a massive sea change in the balance of the economy."

Bond solution

The report calls on the government to be bold in tackling the problems faced by the economy.

It should consider borrowing money to fund mortgage lenders to attempt to stabilise the housing and exchange markets, minimising the risk of over-reaction, the report says.

The suggestion of funding banks is similar to that which the Bank of England is set to unveil on Monday.

It is set to swap about £50bn of government bonds for British banks' mortgages, the BBC has learned.

Mr Spencer said that this was the best solution to the crisis.

"Like it or not the Treasury must use its standing in the international markets to borrow and fund the mortgage lenders directly," he said.

The report added that a UK recession was unlikely, helped by high employment levels as well as growing exports on the back of the falling pound.

"We should be able to adjust to this situation if the government take decisive action now," Mr Spencer said.

"Nonetheless, if it does not, the risks are plain to see."