Interest rates must not rise in 2011, warns think tank

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The Bank of England must not raise interest rates this year, despite facing 12 months of soaring inflation, the Ernst & Young Item Club has warned.

In December inflation hit a new high of 3.7% and, as a result, many economic commentators are expecting the Bank of England to start increasing interest rates earlier than anticipated. 

However Ernst & Young's respected economic forecasting group has warned that any such increase would be premature and put the UK's economic recovery at risk.

The Item Club's quarterly forecast anticipates that CPI (the government's preferred measure of inflation) will peak at 4% in February, placing enormous pressure on Mervyn King and his colleagues in the Monetary Policy Committee to raise rates. However the Item Club is urging the MPC to hold its nerve, expecting inflation to drop back to its 2% target by 2012, once temporary pressures fall away.

Saving in 2011 doesn't have to depend on the interest rate however, read our 10 golden rules on saving and watch Moneywise TV's episode on how to cut your weekly outgoings.

Peter Spencer, chief economic advisor to the Ernst & Young ITEM Club comments: "It's going to be a tense start to 2011. The fiscal retrenchment will keep GDP subdued, while commodity price rises and the VAT hike (VAT rises to 20%) will push inflation close to 4% and leave the MPC agonising over whether to increase the Bank base rate.

"However it's vital that the MPC stands firm. These are temporary pressures, domestic cost inflation remains low and CPI inflation will come back to heel in 2012 once the VAT increase falls out of the figures next January. A premature rate rise would boost the pound, weakening the UK's ability to increase its exports – particularly into the emerging markets – which we have long maintained hold the key to the UK's economic recovery."

Following a bad 2010, the Item Club doesn't hold much fresh hope for squeezed consumers in 2011. In addition to rising VAT, increasing commodity prices and April's National Insurance hike, the Item Club also expects pay rises to remain below inflation this year.

Read Emma Lunn's article on how to negotiate a payrise this year

Spencer adds: "It's going to be tough for UK consumers this year, who are going to have a lot less spare cash in their pockets. Household incomes are going to be squeezed yet again. Add to this the prospect of rising unemployment, and the outlook appears decidedly bleak.

"However VAT and other increases will fall out of the CPI figures next spring, easing the pressure on disposable incomes, allowing households, the high street and the housing market to begin to share in the recovery in 2012."

Feeling the squeeze? Read our 10 ways to spend less in 2011

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