National Institute urges Bank to sanction 'pre-emptive' rate rise

The Bank of England must raise interest rates next week to show it is prepared to take "pre-emptive" action to quash rising inflationary pressures, a leading independent think-tank said today.

Rising inflation, a fall in the pound's exchange rate and a rise in inflationary expectations among financial markets and UK households have made a rate increase an urgent necessity, the National Institute for Economic and Social Research said. "There is a strong case for the Bank to make a pre-emptive action to say 'we won't allow inflation to go up'," Professor Ray Barrell, at NIESR, said.

His comments came as the institute raised its growth forecasts for next year and 2007 in its quarterly forecasts, published today. It forecasts 2.5 per cent this year and 2.8 per cent in 2007, both up by 0.1 percentage points since its January outlook.

The Bank's Monetary Policy Committee meets next Wednesday and Thursday against a background of a slowdown in consumer spending and service sector activity. But Professor Barrell said: "The Bank is targeting inflation, not growth. Inflation is rising slightly, there's been a depreciation in sterling and there is a drift in inflation expectations on the bond market and among people. If you are a central bank that last one should make you wary. You can't allow inflation to take off."

Last week an NOP survey commissioned by the Bank showed that households expect inflation to hit 2.8 per cent over the coming year, well above the Bank's 2 per cent target.

Inflation has risen from 1.1 per cent to a peak of 2.3 per cent in October, although it has fallen since. However, analysts fear that soaring oil, petrol and utility costs will feed through.

The markets are pricing in another quarter-point rise, and sterling has fallen 4 per cent over the past year. NIESR warned that the UK's current account deficit could trigger a further fall in the pound that would push inflation up. NIESR's call contrasts with the view in the City. A poll by Reuters last week showed 15 out of 28 economists expected rates to fall over the coming 12 months.

Professor Barrell played down the risk that a rate rise now could be an error if fuel prices and inflation expectations subsequently fell. He said: "We know that a quarter-point rise will do little to the economy but inflation is the one thing they should take seriously."

Meanwhile, figures from Nationwide Building Society indicated the strong rises in house prices might be running out of steam. It said prices rose 0.1 per cent this month after March's 1.1 per cent, taking the annual rate of house price inflation to 4.8 from 5.3 per cent.