OECD cautions against rates rise

The Bank of England can afford to keep interest rates unchanged and wait to see whether inflation picks up as a result of higher wages and energy prices, a leading thinktank said today.

In its half yearly economic outlook, the Paris-based Organisation for Economic Cooperation and Development predicted a rise in inflation in the short term, after the recent jump in domestic gas prices; beyond that, inflation should fall back below the Bank's 2% target. The Bank of England gave the same scenario in its May inflation report.

At its May meeting, the Bank's monetary policy committee was split three ways, with six members voting to keep rates unchanged at 4.5%. One member voted for a cut, while one favoured an immediate increase.

Most City analysts now believe that the next move will be up, but the question is whether a rise will occur this year or next.

The OECD said that it believed the Bank could afford to wait.

"The Bank can afford to keep interest rates unchanged while waiting to see whether underlying inflation maintains its recent moderate path, or picks up as a result of higher wage inflation and spillover from higher energy prices," the OECD said.

The OECD said the risks to its growth forecasts were roughly balanced but several factors could cause inflation to drop more rapidly below the 2% target.

"First, import price inflation could fall back more quickly than projected. Second, net immigration might remain at its current high level, boosting the labour force and further damping inflationary pressures. Finally, the spillover from energy prices into wage pressures may not eventuate," the OECD said.

The thinktank pencilled in economic growth of around 2.5% for this year and 3% in 2007.

Howard Archer, of Global Insight consultancy, said: "We share the OECD's view that the Bank of England can afford to hold fire on interest rates for the rest of this year, and then will only need to tighten monetary policy very modestly in 2007. "Critically, there is still no evidence that wages are rising, and we expect this to remain the case given the increased slack in the labour market. Meanwhile, significant uncertainties remain about the future strength of consumer spending, as well as the ability of business investment and exports to make a significantly improved contribution to growth on a sustained basis."