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Thursday, 26 May 2011

Bank of England must raise interest rates by year-end, OECD warns

The Telegraph reports today that the Organisation for Economic Co-operation and Development has warned that The Bank of England should raise interest rates before the end of the year or risk letting inflation run out of control.


Despite downgrading its growth forecast for the UK for the third time in six months, it said: "Normalisation of interest rates will need to start during 2011 to stave off significant increases in inflation expectations." Inflation is running at 4.5pc, more than double the Bank's 2pc target, but has so far showed little sign of becoming embedded in wage settlements.

The OECD's comments echoed another call from Andrew Sentance to begin policy tightening urgently, in his final speech as a member of the Bank's Monetary Policy Committee (MPC).He said: "Continuing to accommodate inflation makes it more likely that a future sharp policy correction will be needed, particularly if persistent high inflation becomes embedded in wage and price-setting. That ... poses a threat to the recovery further down the track."

Mr Sentance has been voting for a half a percentage point rise in rates to 1pc since February. He will be replaced on the MPC on June 1 by Ben Broadbent, the former Goldman Sachs economist, who is expected to take a softer line on inflation, having said he broadly supports the Bank's decision to keep rates at their record low for as long as they have.

The OECD reiterated its support for the Chancellor's deficit reduction plan, saying it "strikes the right balance" but expects the deficit to account for 7.1pc of GDP in 2012 compared with the official forecast of 6.2pc for the 2012/13 financial year.

Unlike Mr Sentance, it expects inflation to drop away after 2012. Mr Sentance said energy and commodity prices "could be in a structural position of scarcity for some time yet, leading to further significant upward price movements". He warned oil prices could treble to around $300 within 20 years and urged the MPC to stop considering commodity price moves "one-offs". 

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