Bank of England urged to keep rates on hold

(SHARECAST) – The Bank of England (BoE) should resist the temptation to raise interest rates in response to rising inflation, forecasting group Ernst & Young ITEM Club has warned, saying such a move could damage the recovery.

The group predicts that the consumer price index, the government’s preferred measure of inflation, will peak at nearly four percent in February, causing the BoE to increase interest rates from the current level of 0.5 percent.

However, it says that the BoE should “hold its nerve” as inflation will fall back below the two percent target.

“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,” said ITEM’s chief economic advisor Peter Spencer.

Recent inflation data, which has largely been caused by soaring global commodity prices, has made the prospect of interest rate rises in the next few months appear more likely. Howard Archer, chief UK and European economist at analyst group IHS Global Insight, said last week that the risk of an interest rate rise before the fourth quarter is mounting.

ITEM predicts that GDP will grow by 2.3 percent in 2011, rising to 2.8 percent in 2012.

“In addition to rising commodity prices, the VAT hike and the increase in employees’ National Insurance Contributions this April, ITEM also expects wage increases to remain below inflation throughout the year,” the group said.

“There is also a significant risk of further increases in unemployment, given the cuts to public spending,” it added.