Bank of England Must `Hold Its Nerve' on Interest Rate, Ernst & Young Says

Ernst & Young LLP’s Item Club said the Bank of England must “hold its nerve” and not raise its key interest rate until the recovery shows signs of overcoming the impact of the government’s budget squeeze.

“With inflation likely to reach 4 percent this spring, the Monetary Policy Committee will come under intense pressure,” the research group said in a report in London today. It should “keep base rates where they are until it is clear that the economy is taking the fiscal adjustment in its stride.”

The bank maintained emergency stimulus last week as it weighed the threats of spending cuts against the risk that higher oil prices and sales tax rate will keep inflation above the government’s 3 percent limit. A senior lawmaker from the ruling Conservative Party called yesterday for increases now, and economists at banks including Citigroup Inc. said they may come faster than previously anticipated.

Inflation may have accelerated to 3.4 percent in December from 3.3 percent in November, according to the median forecast of 31 economists in a Bloomberg News survey. That would be the highest in seven months. The Office for National Statistics will publish the data at 9:30 a.m. in London tomorrow.

In a sign of mounting price pressures, input-price inflation accelerated to 12.5 percent in December from 9.2 percent, data last week showed.

Growth Forecasts

The Item Club, which uses the same forecasting model as the U.K. Treasury, revised its prediction for economic growth this year to 2.3 percent from 2.2 percent. It cut its 2012 projection to 2.8 percent from 2.9 percent.

“The fiscal retrenchment will keep gross domestic product subdued,” while inflation will “leave the MPC agonizing” over the interest rate, Item Club chief economic adviser Peter Spencer said. “However, it’s vital that the MPC stands firm.”

The group also said that exports and investment will be “sufficiently strong” for the recovery to continue and that inflation will slow.

Societe Generale SA, BNP Paribas SA and Citigroup this month changed their forecasts for rate increases from a record low of 0.5 percent. Citigroup says it sees two quarter-point rate increases in 2011 instead of one, and the other banks say the first move will come this year, not in 2012.

Michael Fallon, a Conservative member of the lawmaker panel that scrutinizes the central bank and the Treasury, told BBC Radio 5 yesterday that the policy makers should start a series of “gradual” rate increases now to avoid sharper rises later.

“I tend to be a ‘now man’ because we’ve had constant reassurances that inflation will fall and it hasn’t fallen,” he said. “Given that rates are artificially low, they’re going to have to go up anyway eventually, I’d rather see them start moving up gradually than go up in a huge jump, perhaps in the autumn.”

In a separate report today, Deloitte & Touche LLP chief economic adviser Roger Bootle predicted U.K. GDP growth of 1.5 percent this year and next and said he sees no change in the central bank rate until at least 2013.

To contact the reporter on this story: Jennifer Ryan in London at jryan13@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net

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