The Bank of England has been urged to “hold its nerve” and not raise interest rates amid predictions that inflation could soar to nearly 4% during the early part of the year.
The economic forecasting Ernst & Young ITEM Club expects a combination of rising commodity prices and the increase to VAT to push inflation to a peak of nearly 4% in February. But it warned that, despite this, any increase to the Bank of England base rate would be premature and could endanger the economic recovery during what was going to be a difficult 12 months.
It added that inflation was expected to drop back to its 2% target in 2012 once temporary pressures fell out of the economy.
The ITEM Club said inflationary pressures would be coupled with below-trend economic growth as the Government’s austerity measures start to take effect, leading to GDP growth of just 2.3% this year, rising to 2.8% next year.
Peter Spencer, chief economic advisor to the Ernst & Young ITEM Club, said: “It’s going to be a tense start to 2011. The fiscal retrenchment will keep GDP subdued while commodity price rises and the VAT hike will push inflation close to 4% and leave the MPC agonising over whether to increase the Bank base rate.
“However, it’s vital that the MPC stands firm. A premature rate rise would boost the pound, weakening the UK’s ability to increase its exports – particularly into the emerging markets – which we have long maintained hold the key to the UK’s economic recovery.”
The ITEM Club warned that consumers would “really feel the squeeze” during the coming year as rising commodity prices, the VAT hike and the increase in National Insurance contributions in April all hit their disposable income. Wage increases are also expected to remain below inflation during the year while house prices are expected to fall by 5%, with only a gradual recovery for transactions forecast for 2012.
There is also a “significant risk” of further increases to unemployment as a result of public spending cuts. The ITEM Club expects the unemployment count to increase marginally to 8.1% during the summer before falling back to 6.8% by 2015.
But there is some good news, with ITEM Club officials anticipating a rise in business investment and exports during 2011 as companies move from cost-cutting mode into expansion mode. UK exports are forecast to grow in line with world trade as firms capitalise on opportunities in emerging markets and the weak pound, rising by 7.3% in 2011 and 9% in 2012.
Mr Spencer said: “It will undoubtedly be a tough year, particularly for employment, wages, housing and the high street while many major uncertainties also remain around the actual impact of Osborne’s austerity measures. The growth in the UK economy all hinges on some major ‘ifs’ and ‘buts’ – the most significant of which, in the next 12 months, is going to be whether the Monetary Policy Committee maintains the Bank base rate at 0.5%.”