The worst is over for the UK economy and recent tight controls on corporate spending have paid off, according to a leading think-tank report.

The Ernst & Young Item Club has suggested that "despite all the doom and gloom of the last few months, the UK economy is fundamentally sound".

The cost to household incomes and balance sheets has been enormous Peter Spencer, Item Club economic adviser

Its latest report on the British economy concedes that UK consumers and businesses have paid a high price for stability, as purse strings have been significantly tightened in both households and company boardrooms.

But the group optimistically predicted that a pick-up in business spending could be closer than previously thought.

Paying the price

Peter Spencer, the Item Club's economic adviser, said the slump in company share values and budgets has corrected "the euphoria" that led to the inflated valuations and spending plans in the run up to the millennium.

The High Street and the housing market are at last succumbing to the force of gravity Ernst & Young Item Club

The result is a much more realistic valuation of companies and their projected earnings.

"This 'adjustment' leaves the economy in much better shape in the long term," said Mr Spencer.

However, he added: "The cost to household incomes and balance sheets has been enormous."

Reality checks

The Item Club's report admitted that the recent black mood about the economy had been fuelled by concerns over slowing consumer spending, falling house prices, a weak business sector and, not least, a possible war with Iraq.

But the group welcomed such a 'reality check' and said it would not lead to the crash some feared.

"In our view this is a healthy development, a sign the High Street and the housing market are at last succumbing to the force of gravity."

The Item Club predicts that the spending boom and runaway house prices that have fuelled recent economic growth will gradually make way for export and investment sectors to take up the running and accelerate economic growth into 2004.

Neighbourly concerns

The biggest threats to the UK come from abroad, according to the Item Club, which pointed to weak trade figures from the US and Germany in particular.

A war with Iraq would also exacerbate the threat and any British involvement would be expensive.

There are very few of us that enter the New Year in better financial shape than last year Item Club

However, the report remains unfalteringly optimistic, arguing that the recent falls in the dollar are simply bringing it back to a more a realistic level - "at last".

In addition, the report predicts a stronger Euro as a catalyst for further rate cuts, "that are needed to revive our continental market".

Safety net

The Item Club, made up of UK or global organisations and sponsored by Ernst & Young, acknowledges that "there are very few of us that enter the New Year in better financial shape than last year".

Many young people are realising they will struggle to afford their first home, while their parents are struggling to create a comfortable retirement.

Nonetheless, the report suggests adjustments to the economy will have ironed themselves out by the end of next year and should ensure that the UK economy is on a more even keel by 2005.

The group is also more confident of a turnaround in corporate fortunes.

"This could mean the green shoots of a revival in business spending will be closer than previously thought.

"Exports from the UK and business investment into the country are poised to at least begin to pick up in 2003."