Interest rate rise will put the recovery at risk, warns BDO

Britain's fragile economic recovery could be put at risk by a premature interest-rate rise from the Bank of England's Monetary Policy Committee (MPC), a leading business adviser says today.

BDO, the accountancy firm, said its research suggests that economic growth in the UK will remain weak during the first half of the year, with its clients gloomy about their trading prospects in the months ahead.

BDO measures businesses' expectations about both output and inflation, as well as gauging their optimism levels. Its output index fell to 94.8 in February from 95.5 a month previously while its inflation index climbed from 104.7 to 105.2. Its optimism index rose slightly to 95.5, but remains well below the 100 level seen as signalling an expectation of sustainable growth.

With inflation expectations running high, businesses continue to expect that the MPC will raise the cost of borrowing for the first time in more than two years in either April or May. However, Peter Hemington, a partner at BDO, gave warning such a move might prove to be a mistake that "could seriously derail growth prospects".

"Although inflation is well above the Bank of England's 2 per cent target, inflationary pressures are not currently feeding into wages, as the labour market has yet to show signs of a sustained recovery – the likelihood of a wage-price spiral therefore still remains relatively low despite recent commodity price increases," he said. "With growth forecasts remaining fragile for the next two quarters, attempts to tame inflation could push up the price of sterling and make exports less competitive, threatening what growth there is in sectors such as manufacturing. The MPC must hold its nerve, or risk scuppering recovery prospects."

The warning follows last week's decision by the MPC to keep rates at just 0.5 per cent, but the minutes of its February meeting are expected to show that three members of the nine-strong body voted for a rate rise, as they did in January. May remains the most likely month for the first rate rise because the MPC will by then have seen the first-quarter GDP figures, which should show that the UK economy has begun growing again. However, stronger data before then could mean a rate rise in April. Lloyds TSB will today provide some succour to the rate-rise campaign, with its latest purchasing managers' index for England showing that the private sector has continued to perform strongly over the past month – and that inflation remains a real threat.

"Our latest survey highlights a solid improvement in private-sector business activity across the English regions, with companies operating in the manufacturing sector showing particularly strong growth," said John Maltby, managing director of Lloyds TSB Commercial.

"On the prices front, good news is far more thin on the ground. Across all English regions firms saw a steep increase in their cost burdens as they were once again hit by higher fuel and raw material costs. Strong cost pressures meant that output charge inflation at private-sector firms stayed uncomfortably close to the record highs seen during the summer of 2008."