Inflation threat fuels possibility of rise in the cost of borrowing

Rising oil and commodity prices on the back of money printing programmes in the US and eurozone mean that the Centre for Economics and Business Research (CEBR) is forecasting UK inflation of 2.7 per cent for the fourth quarter of 2012, sharply higher than its previous forecast of 1.7 per cent and well above the Bank of England’s target of 2 per cent.

Combined with predictions of a return to economic growth during the first three months of the year, the news could increase pressure on the Bank of England governor Sir Mervyn King and his colleagues on monetary policy committee (MPC) to consider lifting interest rates from their historic low of 0.5 per cent.

Andrew Sentance, a former MPC member, yesterday said that rising interest rates “could soon be back on the agenda” because of mounting evidence that the economy is growing, albeit slowly.

Official figures due for release on Wednesday are widely expected to show a modest rebound in GDP for the first quarter of the year, following a 0.3 per cent contraction at the end of last year.

The Office for National Statistics is likely to reveal that the economy has narrowly avoiding a recession, with most analysts’ estimates hovering between zero and 0.2 per cent growth for the first three months of 2012.

But economists admit there is “major uncertainty” about the performance, particularly as official figures are often gloomier than industry surveys.

While industry surveys have pointed to strong growth for the manufacturing and construction sectors in 2012, official figures paint a different figure.

ONS data showed manufacturers saw steep declines in February, while construction suffered hefty falls in January and disappointing growth the following month.

Think-tank the Organisation for Economic Co-operation & Development recently said it expects the UK’s economy to have declined 0.1 per cent in the first quarter.

The CEBR said its new forecast means that inflation “will have been above the 2 per cent [Bank of England] target for over three years and may not fall to that level for a further three years”.

The think-tank also said it had revised up its forecast for gross domestic product (GDP) in 2012 from minus 0.4 per cent to plus 0.3 per cent, but growth in the period to 2016 is forecast to average just over 1 per cent a year.

CEBR chief executive Douglas McWilliams said: “Our growth forecast is not as miserable as our last forecast in January, but the inflation outlook is worse because of high oil and commodity prices.

“Inflation used to be driven by labour costs. Now it is driven by high and rising demand for oil and other primary commodities from the emerging economies in the Far East. We could only opt out of this by pushing up the exchange rate to a level that made the UK even less competitive. So it looks as if inflation above target is a price we may have to pay for some time.”

The central bank admitted last week that a recession was still possible but it was encouraged by a wide range of surveys and data for the powerhouse services sector, which point towards underlying growth in the first half of the year.