The Bank of England may need to raise interest rates to as high as 5% to cool inflation, according to a think tank. The National Institute of Economic and Social Research (NIESR) warned that the longer the Bank deferred further increases, the more embedded inflation would become and the larger the eventual rise in rates would be.
The warning follows the Bank's first rate rise in three years earlier this month, when its base rate increased from 3.75% to 4%. The move affected nearly one million borrowers on floating rate mortgages, as well as others coming off fixed rate deals, and could feed through to other forms of borrowing. It could also boost savers if providers pass the rise on.
Inflation Forecast and Impact on Households
In new forecasts, NIESR said the consumer prices index measure of UK inflation would rise from 3.5% now to a peak of around 4.4% in February, up from the 3.8% peak predicted in July. Rising inflation would hit poorer households hardest, as they have no choice but to buy less rather than adjust spending or dip into savings, it said.
According to NIESR's analysis, rates need to go as high as 5% to tackle the risk of second-round inflation effects, which are expected to show up early next year when companies set their wages and prices.
Criticism of Government Fiscal Policy
NIESR also criticised the Government's fiscal policy, arguing that major spending drives remain unfunded, including on defence, social care and disability. In last month's autumn Budget, Chancellor John Healey confirmed that the UK's fiscal headroom would reduce to £14.5 billion from £23.6 billion, linked to a jump in debt interest costs for the past year.
NIESR said plans to balance the public finances rely heavily on restraining public spending scheduled for the years ahead. Its analysis found that if the plan slipped by as much as previous ones have, the Government's fiscal rules would be missed by around £30 billion. The think tank argued that the Chancellor did not seize the opportunity at the autumn Budget to put the public finances on a firmer footing, with difficult decisions about taxes and spending largely postponed.
GDP Growth Forecast
In the latest report, NIESR forecast UK gross domestic product (GDP) at 1.6% this year, stronger than a previous prediction of 1.4%, driven by Government spending and business investment, including on AI. GDP is forecast to slow to 1.1% next year, lower than the previous projection of 1.3%.
