GLOOM over the eurozone economy deepened yesterday as a leading international think-tank sharply cut its growth forecast for the 12-nation bloc and issued a powerful call for urgent cuts in interest rates.

In the latest blow to hopes for European economic revival, the Organisation for Economic Co-operation and Development cut its forecast for eurozone growth this year to just 1.2 per cent — down from its previous 1.9 per cent projection.

Giving warning of an “abrupt weakening” in activity and “sagging consumer and business confidence”, the OECD ratcheted up pressure on the European Central Bank to make early and steep cuts in eurozone interest rates.

Jean-Phillippe Cotis, the chief economist at the club of the world’s 30 rich economies, said that action by the ECB to cut rates “significantly” could play an “immediate role” in better management of demand in the eurozone economy.

“The case for easing the monetary stance in the euro area looks indeed rather compelling,” he said.

Weaker activity in the eurozone, Britain’s biggest trading partner, was a key factor behind the OECD also cutting its forecast for UK growth in 2005, from 2.6 to just 2.4 per cent. That compares with Gordon Brown’s optimistic 3 to 3.5 per cent projection.

Pessimism over UK prospects was further fuelled by much worse than expected official figures for business investment, showing that this dropped by 0.1 per cent in the first quarter — the worst figure for two years.

The threat that the Chancellor will be forced to raise taxes in the midst of a consumer downturn was also raised by the OECD.

Mr Brown can expect extra receipts from companies and income tax, it said. But it argued that without a rise in tax rates the extra revenue would be “barely sufficient” to cover planned spending. This would mean that heavy public borrowing, at 3 per cent of GDP, fails to fall as the Chancellor expects.

The OECD backed the growing expectation that UK interest rates have peaked, a view that won support last night from Richard Lambert, a member of the Bank of England’s Monetary Policy Committee.

But Capital Economics, a leading City consultancy, today gives warning that, while it believes that the slowing economy could lead the Bank to cut interest rates to 3.5 per cent or less over the next few years, this will not be sufficient to forestall weaker growth.

Capital’s analysis warns that “payback time” has arrived after the Government’s spending drive and heavy borrowing. “It looks very likely that taxes will rise in the next year or two,” it says, arguing that the resulting period of tighter fiscal policy could knock a full percentage point of the economy’s annual pace of growth.

The consultancy concedes that Britain’s public finances are in a stronger state than those of competitors. But it says that “markets could punish the Government heavily for further fiscal laxity”.

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