Forecasters see deeper recession but higher rates

The recession will continue deepening for another six months, but the Government will still be forced to raise interest rates by the end of next year to bear down on inflation, the London Business School forecast yesterday.

The LBS's picture of continuing recession is reinforced by the Confederation of British Industry, which yesterday predicted that pay settlements would lurch down again, to below 4 per cent.

The CBI's quarterly industrial trends survey, due tomorrow, will also report a sharp drop in business confidence and excessive stocks of unsold goods in company storerooms. Both threaten a further worsening in the plight of manufacturing industry.

Once recovery gets under way next year, national output in 1993 will by 0.9 per cent higher than in the previous year, the LBS predicts. This is barely a third the growth rate it forecast in June.

The LBS argues that the stimulus to recovery from lower interest rates and the fall in the pound has been offset by the blow to confidence from the spectacular unravelling of the Government's economic strategy.

'Since the withdrawal of the pound from the ERM, the policy stance has eased but insufficiently, we believe, to reverse the downward momentum,' the LBS concludes.

The short-term effect of the sterling devaluation will be to increase import prices and widen the current account deficit next year to more than pounds 20bn, from pounds 13bn in 1992. The upward boost to price increases will take a year to feed through, pushing inflation to about 5 per cent in 1994.

Unemployment is expected to top 3 million next year and the shortfall between government spending and tax revenue to continue widening until 1995, when it will peak at pounds 43.4m.

The CBI said that lower pay increases would put companies in a better position to take advantage of the devaluation.

Its latest pay databank reports that settlements in manufacturing averaged 4.2 per cent in the third quarter of 1992, little changed over the past year. Settlements in the service sector averaged 4.4 per cent in the first half, down from 6 per cent in the second half of 1991.

A Bank of England spokesman said Friday's leap in overnight interest rates from 17 to 100 per cent reflected a shortage of funds and had little significance for interest rates generally.

Three-month rates were unchanged on Friday at 8 per cent, suggesting market expectations had not altered.