City alarm over interest rates

FEARS about the outlook for the economy are growing following mounting evidence that rising interest rates are knocking consumer and business confidence.

City economists say recent surveys showing unexpected falls in activity and optimism suggest growth may have peaked. But concerns about the housing and borrowing booms, together with continued robust growth in the dominant services sector, mean the Bank of England will continue lifting rates in coming months.

The London Chamber of Commerce today became the latest organisation to report waning confidence in the face of higher borrowing costs. A balance of only 11% of firms in the capital believe the economy will improve over the next year, compared with 31% three months ago and 41% six months ago.

LCC president Derek Sachs said: 'The health of the economy has been reliant on high levels of consumer and public spending. Coupled with a return to dangerously high mortgage commitments in the capital, a further rise in interest rates or slide in confidence could have serious repercussions for economic stability.'

The LCC findings come in the wake of the recent GfK consumer confidence barometer showing that sentiment-took an unexpected dive in June, lending weight to the growing conviction that households may finally be feeling the pinch from higher interest rates.

Meanwhile, the latest CIPS/Reuters purchasing manager reports, regarded as reliable indicators of future growth, showed manufacturing and service sector activity eased in June. There are tentative signs the roaring housing market may be coming off the boil, and the stock market is failing to make headway.

Jonathan Loynes at Capital Economics said: 'Because the survey data tends to signal turning points in the cycle earlier than the official data, the upshot is that the recent falls suggest that activity could slow considerably in the second half of the year.

'Meanwhile, we are likely to see a period in which the official data remain strong. Interest rates have some way further to rise yet.' The consensus among economists is for the economy to expand by 3.1% this year, with growth slowing to 2.6% in 2005.

Peter Spencer, chief economic adviser to the Ernst & Young ITEM Club, warns that London is more vulnerable than other regions. 'London and the South-East remain more heavily exposed to a slowdown in the housing market, and post-election cuts in public employment will also affect the London area disproportionately,' he said. He also predicted Chancellor Gordon Brown is on course to break his public finances Golden Rule.

George Buckley at Deutsche Bank expects strong growth in the second half, with higher rates failing to bite until the turn of the year. 'We have seen this lull before only for it to be followed by a boom a couple of months later,' he said. 'We're reluctant to call the top of the cycle just yet.'