Interest rate hike 'likely on polling day'

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Voters should be braced for a hike in interest rates as they walk to the general election polling booths, a respected independent think tank warns today.

Voters should be braced for a hike in interest rates as they walk to the general election polling booths, a respected independent think tank warns today.

Strong economic growth in the new year following the unexpected rebound in the final quarter of 2004 will be enough to prompt the Bank of England to tighten monetary policy, the National Institute for Economic and Social Research (NIESR) said.

The NIESR expects the economy to grow by 0.8 per cent in the first quarter of this year, after the 0.7 per cent in the previous quarter that defied forecasts of a meagre 0.4 per cent.

The Bank traditionally prefers to move interest rates in months such as May that coincide with its quarterly inflation report. The first estimate of GDP is published on 22 April, a fortnight before the Bank's Monetary Policy Committee sets interest rates on 5 May - the odds-on favourite date for a general election.

Martin Weale, the institute's director, said: "The fourth quarter's figures must increase the chance of an interest rate increase in May." That decision would be a demonstration of the strengths of the Bank's independence on monetary policy, as it would doubtless send shockwaves through the Treasury.

Mr Weale said he believed that rates should already be at 5 per cent because of the inflationary pressures building in the economy. "A number of developments have occurred in recent months that provide further stimulus for the economy," he said. Market interest rates had fallen, oil prices had weakened and equity prices have risen sharply.

The institute said the economy would grow above trend over the coming two years, with GDP growth of 2.75 per in both 2005 and 2006. Its forecasts factor in a slowdown in consumer spending, from 3.3 per cent last year to 1.4 per cent in 2006, offset by a rebound in exports.

However the picture was less rosy for the public finances. NIESR warned that Gordon Brown, the Chancellor of the Exchequer, would have to raise taxes by £13bn in the next parliament to solve a structural deficit in the public finances. The figure, which is equivalent to more than 4p on the basic rate of income tax, comes just a week after the Institute for Fiscal Studies identified an £11bn shortfall.

Rebecca Riley, an NIESR economist, said the Chancellor had only a one in five chance of meeting his golden rule to balance the current budget over the economic cycle. She said that under the Treasury's forecast the cycle would end in 2006, by which time the Government would have racked up a deficit of 0.1 per cent of GDP, or £13bn in current money.

She said that the Government could ensure that it met the rule - which dictates that the Government must only borrow to fund long-term investment across an economic cycle - by saying that the cycle ended at the end of last year. But this would leave the UK starting a new cycle with a large deficit for 2005-06, making it urgent that the Government raised taxes.