OECD warning puts pressure on Bank to up rates

Published on Wednesday 26 May 2010 20:36

BANK of England Governor Mervyn King is facing pressure to raise interest rates sooner than expected after a respected European think-tank yesterday made a surprise call for UK borrowing costs to rise this year.

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The Organisation for Economic Co-operation and Development (OECD) warned of the threat of mounting inflation and pressed the Bank's monetary policy committee (MPC) to consider rate rises from the summer. It would like to see borrowing costs of 3.5 per cent by the end of 2011.

Although inflation has remained stubbornly above the Bank's 2 per cent target this year, King has so far insisted that the financial crisis was "far from over" and recently hinted that rates were therefore likely to remain at their record low of 0.5 per cent in the short term.

But the OECD warned yesterday that faster action was needed to tackle inflation, which hit a 17-month high of 3.7 per cent in April.

The unexpectedly high cost of living this year has been blamed on short-term factors such as fuel prices and the reinstatement of the 17.5 per cent VAT rate in January. But even so, the OECD said interest rates needed to return to more normal levels.

"Notwithstanding the temporary nature of these price developments, the gradual drift up of some measures of inflation expectations implies a need to increase interest rates earlier than previously thought and no later than the last quarter of 2010," the group said.

The OECD predicts the UK economy will expand by 2.2 per cent this year, rising to 2.6 per cent in 2011. This compares to a forecast from Alistair Darling in the last Budget of 1-1.5 per cent GDP growth in 2010 and 3-3.5 per cent in 2011.

However, David Kern, chief economist at the British Chambers of Commerce, warned against hiking rates while the economy remains on a knife edge. He said: "Raising rates too early would be a big mistake and would push us into a double-dip recession," Kern told The Scotsman. "The new government appears to be adopting a tougher approach to the fiscal side of the economy by cutting the deficit in a more determined way. My view is that will make it easier for the Bank to keep interest rates low."

The BCC expects rates will rise marginally in the closing three months of the year but forecasts they will remain low while the government pushes through austerity measures.

In contrast, the OECD said the coalition government's harder line on the public finances would "leave room" for interest rates to rise sooner. The think-tank's latest forecast was published just a day after official figures showed the British economy grew more than previously estimated in the first quarter, with GDP output upgraded from 0.2 per cent to 0.3 per cent.

The OECD said British households would continue to feel a squeeze in the second half of the year but the recovery would swing into full gear in 2011.

"The recovery will gain momentum in 2011 when household consumption and business investment start to grow more robustly," it said.

Yesterday's OECD report contained similar calls for monetary policy tightening in continental Europe and the US. It said the global economy was recovering faster than expected with Asia leading the way, and forecast global growth of 4.6 per cent this year, up from its previous estimate of 3.4 per cent.

&#149 US Treasury secretary Tim Geithner called for a "carefully designed global approach" to financial reform during a European tour yesterday.