Bank of England urged to slow market without 'overkill'

The Bank of England and the new chancellor of the exchequer are being urged to tread the line between calming the "over-exuberant City" and damaging the economy as a whole with high interest rates.

The Ernst & Young Item Club summer forecast predicts GDP growth in 2007 of 2.9 per cent and of 2.5 per cent in 2008, but warns that the monetary policy committee (MPC) must not try to squeeze the economy.

In particular it highlights the problem that while the business and financial sector represents 28 per cent of GDP, it is currently providing over half of GDP growth. The upshot is that while finance booms, other sectors may be feeling the effects of monetary tightening more greatly.

Peter Spencer, chief economic advisor to the Ernst & Young Item Club, said: "Everyone is getting worried about monetary growth and interest rates. But, the economy is not going to take a tumble, particularly with the global picture so firm.

"The bank has acted forcefully, but it now needs to be careful not to squeeze the UK economy too hard. The MPC needs to rebalance the economy and cool the housing and financial markets, without jeopardising exports."

The report predicts that interest rates will increase to six per cent, which should be enough to cool the housing market and keep inflation low - which should fall with energy prices.

Looking towards the city, the report highlights the danger of the Bank of England putting the housing market at risk with higher interest rates aimed to slow the financial sectors.

Mr Spencer said: "Our worry is that the buoyancy of the business and financial sectors will continue unabated, and that rates will need to be raised further to subdue this exuberance. If that happens, the housing market and the high street will be very exposed.

"These developments have the potential to cause a major slowdown in the consumer sector."

However, he added that problems in the US sub-prime market were likely to slow hedge and private equity funds through raising the cost of debt.

"With a bit of luck, this will just blow away some of the froth at the top of the market," he concluded.