CBI stokes talk of interest rate rise in spring

The CBI last night prompted fresh speculation in the City about a spring increase in interest rates when it reported that strong demand for labour was adding to inflationary pressures in the economy.

Reporting evidence that its members were struggling to fill vacancies, the employers' organisation said it expected borrowing costs to rise during the second or third quarter of this year.

The CBI's forecasts followed the release of the minutes of the Bank of England's monetary policy committee meeting earlier this month, which broke the run of five meetings at which the nine members had been unanimously in favour of keeping borrowing costs at 4.75%.

Paul Tucker, the Bank's director in charge of financial markets, said the likelihood that inflation would be above its 2% target in two years' time meant there was no reason to delay pushing up rates to 5%. The other MPC members, however, adopted a wait and see approach, as they have done every month since the last rise in August 2004.

Despite the caution, the minutes said "some members noted that an increase might be warranted in due course if the economy evolved in line with the Bank's central projections".

Michael Saunders, a Citigroup economist, said the fears of a slowdown in activity expressed by the Bank a few months ago were receding, and added that the likeliest date for an upward move would be at the MPC's meeting in May.

He said a March increase was unlikely, given the Bank's uncertainty over the state of the housing market and the strength of consumer spending, while a move in April would clash with a probable general election campaign.

Should polling day be May 5, as expected at Westminster, the Bank would delay its meeting and announce its decision on May 9.

The CBI said that on the basis of its monthly snapshot of manufacturing and quarterly forecasts for the economy, the outlook remained one of healthy growth that would lead to a "modest build-up in inflationary pressures".

"The economic outlook for 2005 and 2006 remains healthy, but the economy is now having to learn to live with full employment, and the risks of a pick-up in core inflation are rising," said Ian McCafferty, the CBI's chief economist. "For individual businesses, though, life remains tough, with profit margins under pressure and many still reluctant to invest."

The CBI expects the economy to grow by 2.7% this year - below the Treasury's forecast of 3%-3.5% - and by 2.6% in 2007. Government spending is predicted to compensate for slower growth in consumer spending, but at the cost of a higher budget deficit than Gordon Brown has pencilled in.

Mr McCafferty said the deficit was likely to be £38.4bn in 2005-06, rather than the chancellor's projected £33bn, and that tax rises or spending cuts after the election were all but certain. "I cannot see how the chancellor can meet the golden rule - borrowing only for investment projects over an economic cycle -given the structural deficit, without some sort of adjustment. We think that means tax increases or spending cuts of £6bn-£7bn a year." He said the CBI would prefer the government to cut spending and would oppose tax rises on businesses.

· Federal Reserve policymakers suggested rates were lower than needed to keep inflation under control and that the pace of any future increases would depend on economic conditions, according to minutes of the US rate-setter's February meeting, published yesterday. Chairman Alan Greenspan and his colleagues boosted interest rates by one quarter of a percentage point to 2.5% at that meeting on February 1-2. It marked the sixth quarter-point increase since the Fed embarked on its rate-raising campaign in June 2004.