British economists warn over rate rise

A premature hike in interest rates could have “disastrous consequences” for the UK economy, a group of influential economists warned today.

The Ernst & Young ITEM Club said the Monetary Policy Committee should hold off raising interest rates before there was reliable evidence that the corporate recovery was fully under way, despite the fact that inflation is expected to remain high this year.

Instead, it said the MPC should keep interest rates on hold at their current record low of 0.5% until November, when a revival should be evident.

The group added that it expected inflation to ease naturally next year, once the VAT increase and other temporary factors passed out of the index.

Peter Spencer, chief economic advisor to the ITEM Club, said: “A rate rise would be perverse at this stage, merely adding to the already intense pressure on UK consumers, as well as increasing the RPI and risking a rise in wage settlements.

“Companies hold the key to UK growth, and a premature rate rise could easily break the key in the lock.”

The group said that with the prospects of a consumer-led recovery clearly “non-existent” at the moment, businesses were likely to take centre stage in the growth of the UK economy.

It expects business optimism to rise on the back of a healthy world economy, leading to a long-awaited loosening of company coffers, with business investment increasing by 12% this year and 14% in 2012.

Mr Spencer said there were signs that companies were beginning to loosen their purse strings, with some spending on vehicles and other easy asset purchases.

But he said if firms wanted to increase their capacity and capitalise on the opportunities that came from the improving world economy, they would need to extend spending to plant and machinery, buildings and overseas market development.

The group expects UK exports to rise by 9.9% this year, although GDP is expected to grow by just 1.8%, before rising to 2.3% in 2012 and 2.7% in 2013.

Meanwhile, the squeeze on households is expected to continue, with real disposable incomes likely to fall for the second consecutive year – the first time this has happened since the 1970s. Unemployment is also likely to edge up to 8.3% early next year.

These factors are likely to put further pressure on the housing market, with property prices expected to resume their downward decline, before stabilising in 2012 and rising the following year.

Mr Spencer said: “The economy will be much stronger next year as inflation falls back and the consumer begins to enjoy the recovery.”

He added that based on the group’s forecasts, the Chancellor was still on track to meet the fiscal target of balancing the books by the end of the current Parliament, but the biggest threat to the recovery was the MPC’s ability to “stay the course”.