British rates stable unless house price collapse

BRITISH interest rates have now bottomed out unless house prices collapse, a report by The Ernst and Young ITEM club said.

Although economic growth is likely to undershoot finance minister Gordon Brown's targets for this year, the cost of borrowing probably won't fall from the current 48-year low of 3.5% this year, according to ITEM, which uses the same model of the British economy as the Treasury.

Any additional monetary stimulus would not have an impact until next year, by which time the economy will have returned to trend growth, risking a return to boom and bust, the report said. "There will be little point in reducing rates below 3.5% as the impetus would only come through next year and by that time the economy will be in upswing," said Peter Spencer, economic advisor to ITEM said.

If the economy grows according to current forecasts a further cut in interest rates would be a "return to an overly aggressive demand- management policy", Mr Spencer added.

A big fall in house prices, however, could trigger further rate cuts. House price inflation has started to slow, the number of mortgage approvals and the turnover of housing stock are down, indicating the housing market has peaked, ITEM said. If this turned into a slide in prices say of 15% it would lead to interest rates being slashed to 2.5%, it said.

House prices are an important factor in the economy in Britain, where most families own their own homes. ITEM said economic uncertainty remains high despite the end of the war in Iraq, but it does not see a repeat of an early 1990s-style housing crash.

"The housing market is cooling off nicely and should stabilise over the next 12 months," Spencer said.

ITEM cut its target for growth in Britain from 2.0% to 1.7% for 2003, bringing it in line with the consensus forecast. If the prediction is correct, then Britain will undershoot the 2% to 2.5% growth predicted by Chancellor of the Exchequer Brown in April.

However, the latest figures from Halifax, Britain's largest mortgage lender, show house prices rising by an annual 21.9% in Britain.

Retail sales figures rebounded sharply in June, up 3% by value on a like-for-like basis, compared with 1.5% in May, according to the British Retail Consortium. ITEM predicted growth will recover to trend levels of 2.5% next year.