'Rate rises and more taxes'

HIGHER interest rates before the General Election and higher taxes after it have been predicted by City experts in the wake of last week's Budget.

The warning came from the Ernst & Young Item Club, a leading think-tank which bases its forecasts on the Treasury's own model of the UK economy.

It said consumer demand was 'far too strong for comfort' and predicted that the Bank of England would have to push interest rates well above 5% to curb it.

Until now, most economists have predicted that interest rates would peak later this year at 5%. They currently stand at 4%.

The Item Club also warned that tax rises after the election are inevitable if Labour returns to power, with Chancellor Gordon Brown facing a potential £4bn hole in the public finances next year and £ 9bn the year after.

The Item Club says it is a 'racing certainty' Brown will breach his golden rule of borrowing only to invest over the economic cycle - and that would mean higher taxes.

It says the extra taxes would pose 'a significant threat to longer-term growth prospects in the UK'.

'Coupled with business worries about increasing regulation, it implies that incentives for enterprise and investment are being undermined.'

In another setback for the Chancellor, accounting firm Numerica warned that the Treasury's Budget figures show a massive shortfall over the next four years.

In that period public spending is due to rise 13.4% while the economy is forecast to grow 10.75%. Numerica chief economist Maurice Fitzpatrick said this gap would leave the Treasury with a £ 25bn shortfall by 2007/08 - the equivalent of 8p on the standard rate of income tax.

'For the Treasury's figures to add up, there has to be a significant increase in the amount of tax raised,' Fitzpatrick said. 'The Treasury have yet to explain how this will come about.'

The Prime Minister will deliver a major speech on the economy in the City later today. He will amplify the message set out by the Chancellor in last Wednesday's Budget that under Labour, economic stability has allowed unprecedented investment in the public services - while the Tories would cut them.

It emerged yesterday that Blair chaired a meeting of senior Ministers at Chequers last Thursday to discuss five-year plans for reforms of key public services.

Blair is frustrated at the lack of delivery of radical reforms in Labour's second term and does not want to make the same mistake if Labour is elected a third time.

The Treasury made no attempt to conceal its irritation with the Item survey. 'Independent forecasts come and go,' a spokesman said. 'We all remember the Item Club predicting recession. They were proved wrong then and they will be proved wrong again.'

The Treasury also said the Numerica accountants had not taken into account extra tax receipts generated by economic growth.