CBI urges Bank to stay calm over inflation and hold interest rates

Inflation in Britain is set to rise because of high energy costs, but the Bank of England should not panic and raise interest rates, the CBI says today.

Its warning coincides with a Bank survey showing a fall in the public's inflation expectations, something that will calm the Bank's monetary policy committee, which has long been concerned that rising petrol and gas prices could push up wage demands.

The CBI believes the UK economy is likely to grow faster than it previously forecast because of a strong world economy, in spite of recent turmoil in the world's financial markets.

It expects the economy - the fifth largest in the world - to expand by 2.4% this year and 2.5% next year, roughly in line with the long-term trend.

The CBI believes consumer price inflation will rise from its current 2.2% level to a peak of 2.5% this year - above the MPC's government-set target of 2% - before slowing down next year as energy prices stabilise and wage costs are more under control.

"Energy prices have rocketed but core inflation pressures are expected to be limited by the low growth of wage settlements, rising unemployment, and the limited ability of businesses to pass higher costs on to the consumer," says Ian McCafferty, the CBI's chief economic adviser.

"Given the temporary nature of the inflation overshoot, the Bank can still deliver its inflation mandate without the need to change base rates. There is an increasing chance of error if the inflation rise is only temporary, then the risk is the Bank could tighten rates too much, too soon and exacerbate a downturn."

The MPC has left base rates steady at 4.5% since August, but a growing number of City economists expect it to raise them this year if inflation moves up.

The Bank's latest inflation attitudes survey, conducted by pollsters NOP, shows the public expects inflation over the coming year to fall to 2.5% from 2.7%.

Almost half of those polled thought interest rates were likely to rise over the next 12 months.

The CBI's upward revision to growth forecasts reflects faster UK export growth, which should boost the manufacturing sector.

It also expects a greater contribution from rising government spending.

Separately, the Royal Institution of Chartered Surveyors says in a report that the construction industry is likely to recover strongly this year and next, after last a slowdown last year.

It warns, though, that wage pressures are starting to increase in the sector in spite of a continuing influx of eastern European building workers, which has, until recently, kept a lid on wages in the industry.