Interest rates must not rise in 2011, warns think tank
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.
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.
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
Monetary Policy Committee
A committee designated by the Bank of England to regulate interest rates for the UK. The MPC attempts to keep the economy stable, and maintain the inflation target set by the government and aims to set rates with a view to keeping inflation at a certain level, and avoiding deflation. The MPC meets on the first Thursday of each month and discusses a variety of economics issues and constitutes nine members: the governor, the two deputy governors, the Bank’s chief economist, the executive director for markets and four external members appointed directly by the Chancellor.
A scheme originally established in 1944 to provide protection against sickness and unemployment as well as helping fund the National Health Service (NHS) and state benefits. NI contributions are compulsory and based on a person’s earnings above a certain threshold. There are several classes of NI, but which one an individual pays depends on whether they are employed, self-employed, unemployed or an employer. Payment of Class 1 contributions by employees gives them entitlement to the basic state pension, the additional state pension, jobseeker’s allowance, employment and support allowance, maternity allowance and bereavement benefits. From April 2016, to qualify for the full state pension, individuals will need 35 years’ of NI contributions.
Invented by a Frenchman in 1954 and ironically introduced in the UK on 1 April 1973, VAT is an indirect tax levied on the value added in the production of goods and services, from primary production to final consumption and is paid by the buyer. Its levying is complex, with a number of exemptions and exclusions. For example, in the UK, VAT is payable on chocolate-covered biscuits, but not on chocolate-covered cakes and the non-VAT status of McVitie’s Jaffa Cakes was challenged in a UK court case to determine whether Jaffa Cake was a cake or a biscuit. The judge ruled that the Jaffa Cake is a cake, McVitie’s won the case and VAT is not paid on Jaffa Cakes in the UK.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
The total money value of all the finished goods and services produced in an economy in one year. It includes all consumer and government consumption, government spending and borrowing, investments and exports (minus imports) and is taken as a guide to a nation’s economic health and financial well being. However, some economists feel GDP is inaccurate because it fails to measure the changes in a nation's standard of living, unpaid labour, savings and inflationary price changes (such as housing booms and stockmarket increases).
The Consumer Price Index is the official measure of inflation adopted by the government to set its target. When commentators refer to changes in inflation, they’re actually referring to the CPI. In the June 2010 Budget, Chancellor announced the government’s intention to also use the CPI for the price indexation of benefits, tax credits and public sector pensions from April 2011. (See also Retail Prices Index).
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
Also referred to as the bank rate or the minimum lending rate, the Bank of England base rate is the lowest rate the Bank uses to discount bills of exchange. This affects consumers as it is used by mainstream lenders and banks as the basis for calculating interest rates on mortgages, loans and savings.