Interest rates might rise to 8%, says OECD

Inflation in Britain will climb above the Government's target and interest rates might have to rise to 8 per cent, according to the mid-year economic report from the Organisation for Economic Co-operation and Development.

The influential Paris-based think-tank said the credibility of Britain's new monetary arrangements had not yet been fully established. In addition, if the 5 per cent fall in the pound this year was not reversed, this would translate into higher inflationary pressure.

The OECD's forecast that consumer price inflation will climb to 3 per cent, above the 2.5 per cent target that the Chancellor, Kenneth Clarke, set out in his Mansion House speech, will come as an embarrassment to him.

He has held base rates unchanged at 6.75 per cent since February, despite warnings in the Bank of England's latest Inflation Report that the inflation target would be breached unless rates were raised.

Shadow Chancellor Gordon Brown said yesterday: ``The OECD does not believe what the Government is saying on economic policy.'' The fact that the organisation's latest forecasts are even mildly critical of the British economy is a contrast to the praise it has heaped on the Government in recent years for its success in deregulating the jobs market.

Today brings the publication of the minutes of the 5 May meeting between Mr Clarke and Eddie George, Governor of the Bank of England. It is widely believed that Mr Clarke turned down the Bank's advice to raise rates after that meeting. Most analysts do not expect any rise in base rates until the autumn or later, thanks to signs that the recovery has begun to slow to a sustainable pace.

The OECD said tax increases and lower public borrowing would rein in demand this year, and previous rises in interest rates would have an increasing impact in slowing the economy next year. "Even so, short-term interest rates may have to be raised further, perhaps to around 8 per cent, to slow demand growth to that of potential output beyond 1996," the report said. Britain could achieve a ``soft landing'' after 1996.

The report forecasts that growth will fall from 3.4 per cent in the first half of this year to 2.9 per cent by the second half of 1996. Unemployment will continue to fall from 8.3 per cent of the workforce to 7.4 per cent.

Dramatic currency movements this year pose a risk to steady growth and low inflation in the industrial countries as a whole, yesterday's report said .

But it concludes that the risk can be contained, taking a rosy view of prospects for the next 18 months, despite a sharp reduction in its forecast for growth in Japan.

``The current expansion in the OECD area has the potential to mature into a phase of durable growth of employment and incomes in a stable, non-inflationary environment.''