Richard Lambert: The risks are on the downside... consumption needs to pick up quickly

Richard Lambert, the Bank of England rate-setter, holds the door open for further cuts

"I have been in East Anglia over the last few days and things have stabilised, but they are not recovering," he says. "In Norwich they even felt that the national data was understating the weakness of house prices."

In a wide-ranging interview with The Independent, he left the door open for a vote for further rate cuts, saying wage growth was under control while the high street and housing market showed few signs of life.

He said the dramatic surge in oil prices had failed to dislodge consumers' trust in the low-inflation environment or knock the Bank's inflation-fighting credibility.

The economy had grown below its long-term trend for the last year, he said. "I feel that the economy has been growing at below trend for three or four quarters," he said, in an interview carried out before the publication of yesterday's downbeat GDP data. "The 64 million dollar question is what is going to happen to the pace of GDP growth over the next 12 to 18 months."

The projection in the latest quarterly Inflation Report is for growth to pick up to about 2.8 per cent. "That seems the best bet but I have felt that the risks were on the downside," he said. "For that forecast to be achieved consumption is going to have to pick up quite quickly, quite soon."

He doubted consumer spending would show any improvement after a lacklustre first half. "Spending on the high street is not getting worse but is not getting better," he said.

Mr Lambert said he did not foresee a full-scale consumer recession, saying the solid labour market and income growth would drive an eventual recovery. "But not to the levels of the glory days of 2003 and 2004," he added.

The former financial journalist said there was virtually no chance of a return to the runaway house price inflation, despite recent signs of a turn in the fortunes in the housing market.

"Right now it looks as if it has stabilised," he said. "My sense of it is that they are moving sideways and will continue for a bit. So far it looks as if house prices are drifting and I can't imagine increases in house prices starting to accelerate.

"My feeling is that house prices between 2002 and 2004 did rise to a level that was above anything one would describe as sustainable relative to earnings, and they are still high."

He said the labour market showed few signs of inflationary pressures with average earnings growth at 4.2 per cent. "That is lower than pretty much anyone would have bet on at the beginning of this year," he said. "Inflationary pressures coming through the labour market have eased a bit. That gives us some comfort."

Mr Lambert said oil was the key issue for the MPC. "The whole committee feels that the big issue is 'accommodate or not accommodate'," he said.

The wider economics community is split over whether monetary policy should ignore the immediate price impact from oil - the "first-round" effect - and respond only to second-round effects of higher wages and shop prices, or raise rates pre-emptively.

Mr Lambert said the three key issues for him were: what was happening to wage deals, inflation expectations and household spending in the wake of the $20-a-barrel jump in oil since the start of the year.

"You look at the bond market and polls of what people think and, as far as you can tell, inflation expectations are well anchored," he said.

He acknowledged concerns of other MPC members who fear failure to react to oil prices, which made up half of the recent dramatic jump in inflation from 1.1 to 2.4 per cent, would be more costly to the economy.

But he said: "You could bring inflation back to [the 2 per cent] target as soon as possible but that would mean a tight monetary policy and it would also bear down on the economy as well. It is a trade-off between the two."

He was also calm about the rise in core - non-oil - inflation, saying it was driven by the fact that recent revisions have shown that the economy was growing faster in the first half of last year than first thought.

He believed the economy will return to stronger health in the medium term. "If you think that the reason for slower household spending was that cash flow had been squeezed by higher interest rates, then I think you might conclude that the squeeze would diminish over time because the jobs outlook is good and incomes are rising."

The MPC will tomorrow be given an appraisal of the current economic situation before its monthly decision next week. Most analysts expect rates to stay on hold - although a growing number are pencilling in November as a likely period for a cut.

In terms of the wider macro-economic picture, Mr Lambert is keenly interested in the issues of import prices and productivity.

He acknowledged that import prices had started to add to inflation after several years of deflation thanks to falling prices of goods such as clothing, footwear and electronic goods.

But he seemed relaxed about the impact on headline inflation, saying: "I feel relatively confident that what has happened to import prices has been anticipated and I don't feel it is new."

Mr Lambert also played down hopes of a productivity "miracle" in the UK after years of underperformance. "There is no great sign of it yet," he said.

He was taciturn about his future, declining to comment on whether he would be interested in serving again after his current term expires next may.

He also refused to comment on what he might do if he left the Bank. Asked about the Financial Times, which he edited until 2001, he would say only that Andrew Gowers, his successor, had done an excellent job, adding that he would have done nothing different.