Plea to keep interest rates low
The Bank of England should keep interest rates at their record low of 0.5% in 2015 to avoid the risk of stagnation and deflation as the country faces continued cuts in public spending, a left-of-centre thinktank has warned.
In a New Year message, the Institute for Public Policy Research (IPPR) called on Bank governor Mark Carney to "freeze, don't squeeze" to avoid hurting household living standards and creating a deflationary spiral.
When he first arrived at Threadneedle Street in 2013, Mr Carney indicated that the base rate could be expected to rise from its historic low after employment fell below 7%. The "forward guidance" policy was later adjusted, as the feared inflationary pressures from wage growth failed to materialise despite falls in the jobless total.
The IPPR's chief economist Tony Dolphin said that even with unemployment at 6%, falling oil prices and sluggish wage growth meant there was still no reason to expect a significant increase in inflation over the course of 2015, and therefore no need for a rise in interest rates to rein in prices.
The greatest risk to the economy is stagnation and deflation caused by rapid rate rises at the same time as both major political parties are committed to cuts in spending, he said.
Writing on the Left Foot Forward website, Mr Dolphin said: "The more likely outcome in 2015 is that low headline inflation rates serve to lock in very low inflation expectations. And the risks appear to be tilted more in favour of deflation, which could be devastating for an economy with high levels of debt, rather than a surge in inflation.
"It is a moot point whether monetary policy or fiscal policy should be tightened first in the UK - should we have higher interest rates or deficit reduction? But there is nothing in the economic outlook to suggest that both need to be tightened simultaneously.
"We will not know the exact path that fiscal policy will take in 2015 and 2016 until after the general election, but at this point it seems likely that it will not deviate greatly from the path set out by George Osborne in his Autumn Statement. This implies a significant tightening of fiscal policy, which will reduce demand and growth.
"Low wage and price inflation appear to be the more likely outcome and when they are combined with the likelihood of a significant tightening of fiscal policy over the next two years, the case for keeping interest rates at their current level look compelling."
Mr Dolphin said that the Bank's 2013 forward guidance on interest rate rises had turned out to be a "mistake", because high levels of involuntary part-time and temporary working meant that falling unemployment had not been accompanied by upward pressure on wages.
With oil prices falling to around 60 US dollars a barrel, there is no reason to believe that GDP growth as high as 3% would trigger "a marked increase in domestic inflation pressures" and no reason to move the base rate up from the record low it has maintained since 2009, he said.