'UK interest rates need to rise faster': Economists

UK interest rates must rise at a faster rate than currently forecast if oil prices stay permanently above $42 a barrel, research showed today.

The Bank of England would have no option but to tighten monetary policy to keep inflation under control, according to the National Institute of Economic & Social Research (NIESR).

Fears over the impact of a permanent rise in oil prices on the UK economy have risen since the cost of crude hit a record high of $49.40 in New York last month.

Although they have slipped back since then, prices continue to hover around 43 US dollars a barrel and could climb again as demand for oil builds during winter.

The NIESR said higher oil prices reduce growth and raise costs, contributing to the build-up of inflationary pressures in the economy.

Much depends on whether the increase in oil prices has been driven by temporary factors, such as supply disruptions in key oil producing nations, or more permanent ones.

Ray Barrell, senior research fellow at NIESR and co-author of the research, said the recent spike in the oil price was driven largely by supply disruptions.

In Iraq, production is only at two-thirds of its target of three million barrels a day following a string of terrorist attacks on pipelines and oil installations this year.

At the same time, markets have been unsettled by potential cuts to output in Venezuela and Russia, where the country’s largest producer Yukos is locked in a stand-off with authorities.

But Mr Barrell said permanent factors such as rising demand in China and India meant that the price of crude was unlikely to slide too far below $36 a barrel.

The NIESR said a permanent rise to $42 would add 0.1% to inflation each year in the eurozone and 0.25% annually in the US.

Output would be around 0.2% lower than it would otherwise be in both regions, although the effects on the UK would be limited as it remains an oil producer and exporter.

However, if oil prices doubled as they did in 1974 and 1979 and stayed high for many years, then the NIESR warned that the economy would slow down severely as output ground to a halt.

This scenario was considered to be highly unlikely as better fuel efficiency in transport and manufacturing meant oil formed a smaller proportion of costs than 20 years ago.

The NIESR research comes just 24 hours after the president of oil cartel Opec said supplies were growing faster than demand.

Speaking at the World Energy Congress in Sydney, Purnomo Yusgiantoro said world oil production is running “1.5 million barrels every day above demand, based on our forecasts”.

He said oil production in the 11 Opec nations, including Iraq, is 29 million to 30 million barrels a day. Opec oil ministers are set to meet in Vienna later this month to discuss ways to bring prices down.