Nomura gloomy over rates and inflation

Economics Editor

The financial markets will be casting an even more beady eye than usual over this week's inflation and earnings figures.

The focus will be on whether the fall in the pound since the start of the year will force the Government's hand on interest rates.

A pessimistic picture of the prospects for both interest rates and inflation was painted by Nomura Research Institute in its latest forecast.

Chris Dillow, Nomura's UK economist, suggests that the Bank of England will have to raise interest rates to 8.5 per cent by the autumn.

He predicts that inflation will breach the Government's target ceiling of 4 per cent next year, even though the economy is poised to slow down sharply.

And Mr Dillow also projects renewed large deficits on the current account of the balance of payments for 1995 and 1996.

The forecast is based on a gloomy assessment about the underlying cost pressures in the economy.

The fall in sterling is likely to keep import prices rising sharply.

A combination of rising earnings and slower productivity growth is expected to push unit wage costs up sharply in the next two years.

With profit margins shielded by the depreciation of the pound, companies will not put up a big fight.

Instead, they will pass the cost increases through to higher prices.

Over the past few months, attempts to push through price increases have been been thwarted by consumer resistance.

Retailers, in particular, have been given one bloody nose after another in the high street.

But Mr Dillow believes that consumers are set to hit the spending trail again.

Rising real incomes after tax, a return of job security and a recovery in house prices will encourage a rundown of savings.

The investment house is also factoring tax cuts worth about £5bn in the November budget.

With consumers getting ready to reach for their wallets again, - consumer spending is forecast to grow by 2.5 per cent in 1995 and 3.7 per cent in 1996 - many companies will be able to get their way on prices, particularly in the services sector of the economy.

However, much of the extra spending power will leak out into imports - hence Nomura's pessimism on the balance of payments.

The forecast suggests that the current account will swing back sharply into big deficits amounting to £9bn in 1995 and £15bn in 1996.

Gavyn Davies, page 25