Homeowners face further worry today as the Bank of England is set to resist calls for a cut in interest rates, despite a fall in house prices and mounting evidence of a sharp slowdown in the economy.

The Bank is expected to decide that rising inflation means that it must reject pleas for relief to shore up the economy and to help households struggling with soaring living costs.

The base rate is likely to be held at 5 per cent despite warnings yesterday from the Organisation for Economic Cooperation and Development (OECD) that Britain faces a bleak two-year downturn with house prices continuing to plunge, consumer spending weakening, and growth failing to revive next year. House prices are expected to fall by “around 10 per cent”, the organisation said in its half-yearly outlook.

The OECD’s bleak assessment contradicts Alistair Darling, the Chancellor, who forecast that growth would recover next year. The OECD gave warning that a £31 billion black hole in the Government’s books could force Mr Darling to raise taxes or cut spending plans in coming years.

Appearing before the Treasury Select Committee yesterday, the Chancellor denied claims of financial irresponsibility over his decision to borrow £2.7 billion to raise tax allowances and compensate those hit by the abolition of the 10p rate. But he said: “If you’re saying should we have gone further and should we have gone faster, yes we should have.”

The OECD predicted that the economy would be hit hard in a property slump fuelled as high street banks keep home loans more costly and harder to come by. Existing loan conditions are expected to “remain tight” for would-be homebuyers and hundreds of thousands of people coming off cheap, fixed-rate mortgage deals, the OECD found. The blight on the housing market will take a toll of consumers’ spending, it added, dealing a sharp blow to the economy’s growth. However, the report added that it did see room for three quarter-point rate cuts in the first half of next year.

Yet the OECD backed the Bank’s expected “no change” verdict on interest rates. It said rising inflation fuelled by surging fuel and food prices meant that the Bank had little choice.

Growth in spending by consumers will drop by a third this year, to a lacklustre 1.9 per cent, and then crash to only 0.6 per cent next year, the think-tank predicted. With businesses also cutting back sharply, the OECD said Britain’s growth next year will sag to only 1.4 per cent, down from an already weak 1.8 per cent this year, and less than half of last year’s 3 per cent.

The prediction of protracted economic woe was the latest challenge to the Chancellor’s much more optimistic view that Britain will bounce back sharply next year, with growth rising from 1.75 per cent to between 2.25 and 2.75 per cent.

Fears that Britain is already sinking into a severe downturn were fuelled as a key survey showed that growth in the vast services sector stalled last month for the first time in more than five years. Worsening conditions were emphasised as services firms, from bars and restaurants to accountants and lawyers, cut jobs, with employment in the sector falling in May at its fastest for 12 years.

The think-tank also sounded an alert over the deteriorating state of the country’s finances. The Chancellor is in danger of breaking his own financial rules and substantial tax rises or spending curbs will be needed to escape this fate, it concluded.

Weakening growth was set to hit tax payments, sending government borrowing soaring by £31 billion more than Mr Darling has planned over the next two years, the OECD’s forecasts showed. The OECD predicted that public borrowing will surge from 3 per cent of national income (GDP) last year, to a hefty 3.8 per cent this year, against the Treasury’s 2.9 per cent prediction. That would add £13 billion extra to borrowing totals, lifting these to £56 billion in 2008-09.

The OECD expects that borrowing will remain stuck at 3.7 per cent of GDP next year, rather than falling to the 2.5 per cent that the Chancellor has forecast – a gap equivalent to £18 billion of extra borrowing. It said that if Mr Darling was to meet his fiscal rules, “it is clear that much tighter fiscal policy will be required in the future if the rule is still to be respected”. That would spell either significant tax rises or more drastic curbs on the growth of government spending that the Chancellor has already laid out.

Explore Economics

• Budget 2008

• The Times MPC

• Autumn Budget 2007

• World Economic Forum

Times Recommends

• UK savings frozen after Landsbanki goes bust
• RBS shares fall under £1 on bailout fears
• Asian stocks rebound on Australian rate cut