OECD urges Bank of England to raise rates

The OECD, the "club" for the world's most advanced economies, has said the UK will experience slower growth than previously expected, but called on the Bank of England to push the Bank Rate up to 1 per cent by the end of this year, and to 2.25 per cent by the end of 2012, compared with the current historic low of 0.5 per cent.

Markets have already priced in much of that suggested hike, as part of a widely anticipated gradual "normalisation" of monetary policy, but it would be be an unwelcome intensification of the squeeze already facing households and businesses. The OECD's call for higher mortgage bills was echoed by a retiring member of the Monetary Policy Committee, Andrew Sentance, who warned in a speech that the Bank's credibility on inflation will "erode" unless action is taken soon.

In it latest economic outlook, the OECD lowered its forecast for the U.K GDP growth this year to 1.4 per cent from the 1.5 per cent it predicted in March and for 2012 to 1.8 per cent from 2 per cent. Both are below the official, Office for Budget Responsibility, projections of 1.7 per cent and 2.5 per cent respectively. Any of these figures would represent a feeble recovery on past precedents. Yet the OECD says that the Bank should raise rates: "A modest increase in interest rates should be taken during 2011 to stave off increases in inflation expectations, which are already elevated."

But: "Unemployment is likely to increase in the short term, reflecting the slow recovery and rising labour force participation". The jobless rate will peak at 8.3 per cent in 2012, from 7.7 per cent today.

However, the OECD continues to endorse the Government's "necessary" strategy to reduce the budget deficit – still the largest among the larger mature economies – provided the Treasury also allows borrowing to rise temporarily if the economy slows, via the "automatic stabilisers". The Treasury has indicated it will do this – £46bn of such cyclical borrowing by 2015 is scheduled in the March Budget.

Ministers have made much of international backing for their plans and will be pleased that the OECD has reiterated its previous warm endorsements. "The current fiscal consolidation strikes the right balance and should continue in line with the Government's medium-term plan to eliminate the deficit, while allowing the automatic stabilisers to work," the OECD said.

But the suggestion that VAT rates on lower-rated items such as children's clothes be "harmonised" to pay for a boost to public spending on infrastructure is unlikely to be taken up.

The OECD concludes that "historically high unemployment remains among the most pressing legacies of the crisis. It should prompt countries to improve labour market policies that boost job creation and prevent today's high joblessness from becoming permanent". Global GDP is projected to rise 4.2 per cent this year and 4.6 per cent in 2012.