Britain’s economy will surge back to life in the next six months following its slow start this year, a leading forecaster has predicted, prompting the Bank of England to raise interest rates next spring – more than a year earlier than its previous projection.
The National Institute for Economic and Social Research (NIESR) said a boom in exports after the fall in the pound and a return to bumper wage rises next year would be enough to increase GDP growth to almost 2% and convince the central bank to increase the cost of borrowing.
Jagjit Chadh, the institute’s director, said a rise interest rates would also have the effect of supporting efforts by high street banks to boost their profits and the reserves needed to protect them against another financial crash.
“We are not talking about a rapid return to higher interest rates, but signalling that process – even if it takes five to seven years – will help banks rebuild their balance sheets and create a healthier financial system,” he said.
In a separate report, Chadh said one of the main reasons for the UK’s slow growth in recent years was the weakness of the banking sector and its ability to support expanding businesses with extra loans. “The finance sector is crucial because every business has to go to a bank to put forward their business plan and get credit,” he added.
NIESR’s forecast comes despite growing concerns that Brexit uncertainty is discouraging companies from investing in the UK and hampering a bounce-back from low growth in the first six months. While foreign firms have bought high-profile properties in the UK since the Brexit vote, including last month’s £1.2bn purchase of the Walkie Talkie building in London, there are few examples of increased investment in new factories.
Official figures last week showed that GDP growth was 0.3% in the three months to the end of June – half the rate of growth in the eurozone – after a rise of 0.2% in the first quarter.
Philip Hammond has also said he was concerned about the decline in household incomes in the last year after a rise in inflation of 2.7% while wages growth remained stuck at about 2%. The chancellor is understood to be scaling back government tax receipts in the light of stumbling GDP growth and pushing back the date when he can balance the government’s books from 2025 to 2027.
Later this week, the Bank of England’s interest rate setting committee will give its own verdict on the strength of the economy in its quarterly inflation report. It is expected to present a gloomier outlook for the economy than NIESR after the economy failed to rebound from a weak start to the year.
The Bank of England’s governor, Mark Carney, shocked financial markets in June when he warned that continued growth in the UK economy would eventually lead to higher interest rates, but is not expected to say this week that it will come as early as next spring.
After the Brexit vote, the Bank’s monetary policy committee cut the base rate as an emergency measure from 0.5% to 0.25%, its lowest level in the Bank’s 323-year history.
Carney is likely to highlight how wages have failed to keep pace with rising prices, hitting real incomes and consumer spending. As one economic consultancy said this week: “The criteria set out by the governor to justify a hike look a long way from being met.”
NIESR said it was bringing forward the timing of the first increase in interest rates to the first quarter of next year following its more upbeat assessment of the next six months. Previously it forecast that a rate rise would take place after the second quarter of 2019, when Britain had left the European Union.
A rise in business investment and productivity would spur a broad-based recovery that would allow the central bank to at least reverse the emergency cut last August. It said: “This rate increase should not be seen as a tightening in policy, but instead as a modest withdrawal of some of the additional stimulus that was injected into the economy after the 2016 EU referendum.”
Chadh accused the Bank of England of confusing the public about the next move in interest rates, saying that a series of speeches by the governor and other members of the MPC “fostered a haphazard debate”, when clarity was needed.
“That is why we have called for a proper debate to start now in a careful, considered and open manner,” he said.