Britain has just enjoyed a year when its economy delivered the strongest growth among industrialised countries and there is an inclination to expect more of the same in 2002.

But the particular factors responsible for underpinning British growth during 2001 are creating a store of potential problems for the government's timetable to seek a referendum in 2003 on sterling's entry into the euro.

The past year's economic performance has, like everywhere else, been heavily influenced by developments in the US, exacerbated by the September 11th terrorist atrocities.

The collapse in capital investment after the excessive expenditure of the late 1990s has been devastating industrial profitability, sending shock waves through the economy.

Problems have been felt mostly in the technology, media and telecoms (TMT) sector. But difficulties have also been widely encountered in the heart of Britain's manufacturing industry.

In Britain, weakness in capital investment and the TMT sector has been offset by an unexpectedly large surge in consumer spending.

The powerhouse behind the spending surge has been - and continues to be - Britain's strong housing market.

Year-on-year house price inflation has been in double-digit figures for the second year running and the number of transactions going into the New Year remains at near-record levels.

Somewhat similar circumstances persist in the US, where buoyant consumer spending and housing markets have so far prevented the economic recession from turning into a rout.

In Europe, although consumer spending trends have remained positive until recently, there has not been the same additional stimulus from the housing market.

Mainly, this reflects the different housing market in most European countries, where house purchases are funded through mortgages linked to fixed long-term interest rates.

In Britain, mortgages are provided on variable interest rates and costs of servicing home loans have fallen sharply, in line with reductions in interest rates.

Falling inflation amidst weakening economic prospects have prompted the Bank of England's Monetary Policy Committee (MPC) to reduce variable interest rates from 6 per cent to 4 per cent this year.

British mortgage rates are now at their lowest levels for 40 years, making homes very "affordable" in most parts of the country. The cost of servicing the average mortgage amounts to only 8 per cent of average disposable income.

With the supply of houses being relatively inelastic, house prices have responded to the increase in demand.

There has also been an increase in expenditure on home conversions, new kitchens, and other furnishings and fittings.

As well, many existing homeowners have released part of the enhanced equity in their homes by refinancing mortgages at larger amounts, thereby raising funds for additional expenditure.

In the process, there has been a very marked increase in structural imbalances in the economy, between the industrial and personal sectors, and between manufacturing companies and consumers.

Going into 2002, the manufacturing industry is being hit by a worsening cashflow deficit. The cash crisis will force companies to scale back inventories, sell assets at distress prices, and downsize activities and costs, notably labour.

The cash deficit is already impacting on prospects for the financial sector.

With loan defaults and bankruptcies sharply on the rise, banks are increasing provisions for potential bad debts among industrial customers for the first time since the mid-1990s.

Even so, optimistic 2002 economic forecasts look for avoidance of recession, with British economic growth continuing to be underpinned by strong consumer spending. The combination of low mortgage rates and low inflation, helped by the recent fall in oil prices, should underpin buoyant household spending.

Also, demand in the economy will benefit from the increase in public spending planned by Chancellor Gordon Brown, particularly on the National Health Service, education and other public services.

Maintenance of Britain's economic growth at a time of weaker performance, if not recession, among European economies may create difficulties for the government's programme of holding a referendum in 2003 on sterling's entry into the euro.

Next year, the Treasury, under Chancellor Brown, will be undertaking the government's assessment of the famous "five economic tests" for deciding whether a clear and unambiguous case can be made for Britain to join the European Monetary Union.

The tests concern sustainable convergence between Britain and economies of the single currency; flexibility to cope with economic change; and impact on investment, the financial services industry and employment.

Economic convergence appears to be extremely unlikely in 2002, unless Britain weakens by more than is expected or European economies emerge quickly from their recessionary difficulties.

Instead, Britain's economic performance is likely to be stimulated by further reductions in interest rates in coming months. Some City analysts predict a reduction from 4 per cent to 3.5 per cent by the spring.

Reductions would help to achieve the convergence between British and euro interest rates needed for sterling's entry into the euro.

However, lower rates in Britain would reinforce the economic growth powered by buoyant household cashflows and consumer spending, allied with higher levels of public expenditure.

Britain's economy has been here before, of course.

The late 1980s policy of tracking lower German interest rates and membership of the Exchange Rate Mechanism fuelled the housing market boom of the early 1990s, which took several painful years to unwind.

Now, there are similar risks that a housing market "bubble" is being created by the MPC, through its reductions in British interest rates towards the level of single currency interest rates of the European Central Bank.

Against this backdrop, the housing market holds the key both to British economic development in 2002 and to prospects for a positive 2003 referendum on sterling's eventual euro entry.

If inflation remains subdued, it may be possible for the MPC to maintain its policy of monetary easing without inflating the housing market to unsustainable levels.

But if the house price boom should develop further momentum, the MPC might be forced to lift interest rates to prick the housing market "bubble", leading to severe financial difficulties.

In those circumstances, all bets on sterling's euro entry would surely be off.