BoE urged to hold interest rates to aid UK recovery

The Bank of England has been urged to "hold its nerve" and not raise interest rates amid predictions that inflation could soar to nearly 4 per cent during the early part of the year.

The economic forecasting Ernst & Young ITEM Club expects a combination of rising commodity prices and the increase to VAT to push inflation close to 4 per cent in February.

But it warned that, despite this, any increase to the Bank of England base rate could endanger the economic recovery.

It added that inflation was expected to drop back to its 2 per cent target in 2012 once temporary pressures fell out of the economy.

The ITEM Club said inflationary pressures would be coupled with below-trend economic growth as the government's austerity measures start to take effect, leading to GDP growth of just 2.3 per cent this year, rising to 2.8 per cent next year.

Peter Spencer, chief economic adviser to the ITEM Club, said: "It's going to be a tense start to 2011. The fiscal retrenchment will keep GDP subdued, while commodity price rises and the VAT hike will push inflation close to 4 per cent and leave the MPC agonising over whether to increase the Bank base rate.

"However, it's vital the MPC stands firm. A premature rise would boost the pound, weakening the UK's ability to increase its exports … which we have long maintained hold the key to the UK's economic recovery."

The ITEM Club warned that consumers would "really feel the squeeze" during the coming year as rising commodity prices, the VAT hike and the increase in National Insurance contributions in April all hit disposable income.

Wage increases are also expected to remain below inflation during the year, while house prices are expected to fall by 5 per cent, with only a gradual recovery for transactions forecast for 2012.