Rate rise would miss the point on inflation, CBI warns

A rise in interest rates would be a "policy error" that would slow the economy without having any impact of inflation, the CBI warned today.

The UK's largest business lobby group forecasts a rise in inflation over the coming months but said it would be a temporary blip that would not feed through to a permanent jump in high street prices or wage claims.

The CBI also lambasted Gordon Brown for his failure to find a candidate for the vacant chair on the Bank of England's interest rate committee for a third successive month.

The CBI's economic forecasts, published today, show inflation staying above the 2 per cent target until at least the end of 2007. It peaks at 2.5 per cent in the new year before falling back to 2.2 per cent by the end of 2007 and back to target in 2008.

Ian McCafferty, its chief economic adviser, said a rate rise would drag growth down even further below trend levels without having any impact on inflation.

He acknowledged there had been a resurgence in inflationary pressure, but said it was a temporary blip on the back of record energy prices.

"This increases the chances of a policy error," he said. "If this rise in inflation is only temporary and fades in 2007, the risk is that we could tighten too early, too high and exacerbate the downturn."

Asked what a quarter-point rise would do to the economy, he said it would cut the CBI's growth outlook for next year to 2.25 from 2.5 per cent. "But it does not do much to inflation," he said. "We see inflation coming back to 2 per cent in 2008," he added. "Given the temporary nature of the inflation overshoot, the Bank can deliver its inflation mandate without the need to change base rates."

The financial markets are pricing in two rate increases by the start of next year, after the Bank published forecasts in May showing inflation above target for the next two years if rates were left on hold at 4.5 per cent.

Last week Mervyn King, the Governor of the Bank of England, said import prices were rising and warned that the MPC would "monitor carefully" households' inflationary expectations.

Opponents of an interest rate rise will be given some relief today by an opinion poll commissioned by the Bank showing households' inflation fears have subsided.

The survey of 2,000 people showed consumers expect inflation to rise to 2.5 per cent over the next 12 months, down from a record 2.7 per cent in its February survey.

The number of people who believe inflation will breach 4 per cent fell to 21 from 24 per cent. However, almost half - 48 per cent - expected a rate rise, up from a trough of 34 per cent last August.

Minutes of June's MPC meeting, published on Wednesday, will show whether any other members joined David Walton in voting for an increase.

The MPC is still likely to have only eight members next month, with no news of a replacement for Richard Lambert, who has left to take the top job at the CBI.

Mr McCafferty said: "It is disappointing that we have not any sign of replacement to fill the empty chair. New members should be appointed as speedily as possible."

The Treasury defended the time taken to find Mr Lambert's replacement. Ed Balls, the Economic Secretary, said last week that the priority was to find the best candidate. He said that the nine-year history of the MPC, which Labour set up in 1997, showed that all the chosen candidates had been well received. He acknowledged there had been a delay but denied it was because of a lack of suitable candidates.