The British economy is on track to meet the chancellor's growth forecast this year despite rising interest rates, the Institute of Directors has said.

Publishing its Summer Economic Outlook, the IoD predicted UK GDP growth of 3.1 per cent in 2004, meeting Gordon Brown's target of between three and 3.5 per cent.

But the survey warned that interest rates could reach five per cent in early 2005.

This could contribute to a slower growth rate of 2.6 per cent next year, it was predicted.

That would fall short of Brown's Budget prediction of three to 3.5 per cent in 2005.

The IoD suggested that further interest rate rises are needed because of the potential for inflation to rise in the future.

It also pointed to a strong growth in household wealth with the potential for stronger consumer spending in the future.

And official statistics may be understating the actual volume of government output and therefore GDP growth, the survey added.

"It was never going to be an easy task to slow the British economy, but it is proving harder than we expected," said Graeme Leach, chief economist at the IoD.

"In the latest IoD Economic Outlook we speculate as to whether there has been a change in consumer behaviour over recent years, with homeowners now prepared to spend more on housing costs, owing to long-term growth in personal incomes.

"Does this mean the UK economy requires shock therapy?  On balance we think the case for a gradualist approach to interest rate rises is still stronger, but it is now a very close call."