Bank warns of slowing economy

BRITAIN'S economy will slow dramatically next year as consumers rein in their spending and the housing bubble bursts, a top investment bank warns today.

In one of the most bearish forecasts to come out of the City, Dutch bank ABN Amro predicts the economy will expand by just 1.9% in 2005 compared with 3.2% this year. That is lower than the City consensus of 2.5% and well below the 3% to 3.5% predicted by Gordon Brown in the Budget. The Chancellor may be forced to cut his forecast in tomorrow's Pre-Budget Report.

A growth slowdown as ABN Amro predicts would blow a hole in the Chancellor's fiscal arithmetic. Most experts believe Brown is already on course to break his Golden Rule - to borrow only to invest - on the assumption that the economy will expand by 3% next year.

ABN Amro says the UK consumer will falter under the pressure of a heavy debt burden and falling house prices. Estimating that house prices are overvalued by 25%, it believes they will fall by 5% next year and by 15% over the next three years, with a risk they will drop even more sharply.

'In 2004, household gearing increased by over 20%,' the bank says. 'This means it was 20% more expensive to service a new mortgage in 2004 than it was in 2003. The two previous times this happened were in 1979 and 1989. Both occasions were followed by slumps in real house prices. So, unlike the Bank of England, we do not believe recent falls in house prices will prove temporary.'

A slowdown in consumer spending growth from 3.2% to 2% will trigger a rise in unemployment in the building and construction, real estate, financial services and retail sectors, the bank predicts.

British firms will be the worst performing among the major economies, earnings growth dropping from 12% this year to just 0.25% in 2005. Profits will be hit because as the economy slows, wages and employment levels will be slow to adjust.

'Real unit labour costs will rise and margins will be squeezed,' ABN Amro says. 'Companies will only begin to cut costs more aggressively once the slowdown has become more pronounced.'

The financial sector looks particularly exposed, especially banks and building societies involved in mortgage lending, it says. Adding to the gloom will be rising inflation, as a fall in the pound boosts import prices.