Cole Moreton: It's the economy, stupid!

The sales are on, the shops are full, but there is still financial trouble ahead. The experts agree on that... yet predictions of how bad it will get vary wildly, as shown here. So can we avoid a recession or not?

RECESSION

No we can't, say the pessimists. Just look at the price tags in the shops: a store that slashes the cost of its leather jackets by 70 per cent may be great for a shivering fashionista in want of a new coat, but many analysts see it as a sign of desperation.

Shops are often losing money just to clear their shelves of costly stock. "It's not inconsistent to have retailers whose profits are falling and yet their sales are going up," says Kevin Hawkins, director-general of the British Retail Consortium. "That's one of the problems of discounting."

Shoppers did not buy as much as expected before Christmas because everyone is feeling the pinch, say the pessimists. The cost of living has gone up and up and left wages behind. So what does that mean in real life?

House prices will stall in 2008, rising by just 1 per cent, according to the Council of Mortgage Lenders. The broker John Charcol actually predicts a 2 per cent fall. That's terrible news if your house is your pension, or you need to sell it for some other reason. Like survival, perhaps: the council predicts that the number of homeowners behind in their repayments by three months or more will go up from 145,000 to 170,000. Repossessions are due to jump by half from 30,000 to 45,000 says Citizens Advice, which will be trying to help 850 newly homeless families a week.

Borrowing will reach a shameful anniversary in April when the first of those totally inadequate 25-year endowment mortgages that were sold in the 1980s come to fruition. There are 5.6 million out there, but only one in five are likely to pay off the debt as intended.

Elsewhere the banks are in trouble because of the credit crisis that began in the United States, but it is customers who are being made to pay, with higher charges and loan refusals. Dodgy unsecured loans may be under greater scrutiny than ever, but British people are unlikely to suddenly find a new way of paying off the huge amount we collectively owe on credit cards and to conventional finance companies.

Bills for heating, lighting, water, council tax and groceries are all likely to rise again. One major factor is the rising price of oil, thanks to volatility in the Middle East and moodiness in the Kremlin, neither of which shows signs of stopping. Inflation will rise to 2.1 per cent as economic growth slows right down, predicts the Confederation of British Industry: "This all makes for an incredibly challenging year for the Bank of England."

The Bank of England holds the key. The main difference between these two sets of expert predictions, the positive and the negative, is how much you think the Bank will cut interest rates and what that will do to the economy. There was a reduction by 0.25 per cent (to 5.5 per cent) just before Christmas and that is likely to happen again soon.

But will that be the last of it? The pessimistic view is yes, more or less: the Bank's natural caution about inflation will prevent any more dramatic cuts, short of a full recession.

Some experts already seem to believe a financial crisis is inevitable: currency traders have started to sell off the pound and it won't be worth $2 again as it was this year. David Woo of Barclays spoke for all the prophets of gloom when he said: "Sentiment towards the UK and the pound can't be more dark and pessimistic than it is now." Brace yourselves.

SURVIVAL

Yes we can, say the optimists. Just look at the queues in the shops: a store that slashes the cost of its leather jackets by 70 per cent may attract new customers who come back again later. But some were reporting good sales even before the discounts kicked in.

Shops in good health include the John Lewis Partnership, which has just had a record week, and Amazon, the biggest online store of them all, which says this has been its "best ever" holiday season. "Saturday was a mega-day," says Tim Denison of retail analyst SPSL. "The busiest shopping day of the year so far."

Shoppers are feeling the pinch, yes, but perhaps not as much as the doom-mongers believed after seeing empty stores in December. What happened, according to the sunnier experts, was a giant pre-Christmas game of chicken. People chose not to buy presents until the last few days or even agreed with loved ones that they would wait for the traditional sales in a gamble that prices would fall. They did. As a result the optimists say other analysts may have over-estimated the effect the credit crisis is having on ordinary people. Can that be true?

House prices may stall in 2008, rising by just 1 per cent as the Council of Mortgage Lenders predicts. But the optimists say that isn't terrible news for everyone. Some see it as a long-anticipated correction in a market that has gone mad. The lengthening amount of time it takes to sell a home puts buyers in control again. And those first-time buyers who can afford a deposit may even find that they can actually buy somewhere to live near their friends and family after all.

Simon Rubinsohn of the Royal Institution of Chartered Surveyors says some people will struggle but does not anticipate a crash. "2008 will prove a difficult year for the housing market, but with falls likely in the base rate, the housing market should be provided with a stable platform."

Borrowing will change dramatically, says Jeremy Gutsche of the forecaster Trend Hunter, who predicts the growth of "peer-to-peer" banking. Under this system, borrowers and lenders are introduced to each other through websites and make private arrangements, cutting out the banks entirely. Some are friends, others strangers who bid in an eBay-style auction for the best interest rates. Admittedly, this is unlikely to happen quickly or stop the continuing growth in the gap between rich and poor.

Bills will go up, almost certainly, but by how much? The Confederation of British Industry prediction on inflation was revised just before Christmas, in the light of the crisis many retailers thought was looming then, and it could be revised again if last week's manic spending continues past the traditional sale period by even a little. The Treasury is much more optimistic than the CBI, conceding there may be a "slowdown" but not a recession.

The Bank of England still holds the key. It could unlock the housing market, ease the pressure on those who are struggling with their mortgages and reduce the amount of debt by taking a big slice off interest rates. A few optimists believe it will happen, including Vicky Redwood of the analyst Capital Economics: "We continue to expect rates to fall more sharply than the markets currently expect," she says, "to perhaps as low as 4 per cent." Smiles all round, then (albeit weak ones). Unless you're living off your savings...