Engineering Employers urge European inflation target for UK

Gordon Brown should adopt the inflation target used by the European Central Bank, as part of a major overhaul of the way the Bank of England sets interest rates, according to the Engineering Employers Federation.

Gordon Brown should adopt the inflation target used by the European Central Bank, as part of a major overhaul of the way the Bank of England sets interest rates, according to the Engineering Employers Federation.

The business organisation says in a new report, published ahead of this week's vote on interest rates by the Monetary Policy Committee, that the current target measure overstates inflation. It says the measure, retail prices excluding mortgage interest costs (RPIX), is "bad news for the economy overall and especially for manufacturing".

The EEF recommends the 2.5 per cent RPIX target should be replaced with a 2 per cent target based on the Harmonised Index of Consumer Prices (HICP). This is the target used by the European Central Bank.

On this measure the UK's record on inflation is excellent. UK inflation is 1.0 per cent, the lowest in Europe, whereas the average is 2.1 per cent. With the current RPIX measure, inflation is only just below the target at 2.2 per cent.

The EEF hopes a switch would persuade the MPC that interest rates could be cut without endangering price stability.

A rate cut would delight the EEF's members, mainly exporting companies struggling to compete in the face of the strength of sterling against the euro.

Some economists believe the UK's high level of interest rates has fuelled the strong pound.

The MPC is expected, on balance, to leave rates unchanged at 6 per cent this week after a 5-4 vote to do the same last month. But most economists believe a further increase is likely, perhaps in October.

The EEF report also urges the Government to draft another economist with experience in industry onto the MPC. Currently only DeAnne Julius has worked in industry, at Shell and British Airways.

The Bank has strongly defended itself against accusations of ignoring industry. But Martin Temple, EEF director general, said: "It is important that monetary policy is aiming at the right target and the MPC has sufficient business insight and experience in its armoury."

The Chancellor has already considered a switch to targeting HICP inflation, and economists expect the move to go ahead eventually, but not until statistical problems have been ironed out. Part of the explanation for the low UK inflation rate on this measure lies in differences in house price measurement.

When the statistical problems are resolved, UK inflation might not look so low compared to the EU average and the apparent scope for interest rate cuts could therefore disappear.

Mr Brown is also reluctant to amend the inflation target too soon in case this is seen in the financial markets as moving the goal posts. A switch is unlikely ahead of the election.

Euro sceptics would also seize on a move towards a European measure of inflation as preparing the ground for the UK's entry into the euro.