Think-tank warns of strong inflation threat: Debate over rates deepens as Clarke-George meeting nears

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A WARNING that the economy will be as vulnerable to inflation when recovery quickens as in previous upturns will be made today by the Institute for Public Policy Research, the left-wing think-tank.

The prediction comes two days before Kenneth Clarke, Chancellor of the Exchequer, and Eddie George, Governor of the Bank of England, consider whether to raise interest rates.

Most City analysts believe that, even if the Governor calls for higher rates, the Chancellor will hold fire because he wants evidence that firms can make the price increases they would like to.

Support for holding the rates as they are has come from Tim Melville-Ross, director-general of the Institute of Directors. 'There is no case for a damaging increase in interest rates,' he says in a survey published today of the institute's members showing a steady recovery in business.

'There are few signs that higher inflation is in the pipeline and if exports, rather than consumer spending, continue to provide the impetus for economic growth it could be next year before the situation warrants a rate rise,' he added.

However, Penelope Rowlatt, who used to forecast inflation at the Treasury, argues that there has been no underlying improvement in the economy that will entrench low inflation.

She says in the latest edition of the IPPR's New Economy that inflation has been low because of the recession, falling commodity prices and unusually strong productivity growth in the early stages of recovery.

Firms will rebuild profit margins by raising prices and wage settlements will be consistent with rising incomes. 'If this takes place, the rate of UK price inflation will climb once again,' she says.

A separate article in New Economy warns that inflation could be pushed up as companies have to bid for scarce skilled labour. Jonathan Haskel and Christopher Martin, of Queen Mary and Westfield College, say that 'by causing higher inflation than would otherwise have occurred, a growing skills shortage may well trigger an early deflation and thus bring the recovery to a premature end'.