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High oil and commodity prices mean inflation may stay above 2.5% all year

New Cebr forecasts released recently indicate that the increases in oil and commodity prices – reflecting the impact of quantitative easing in the US and Eurozone – mean that the inflation forecast for this year has been revised sharply upwards from 1.7% for Q4 2012 to 2.7% for that quarter.

This new forecast means that inflation will have been above the 2% target for over 3 years and may not fall to that level for a further three years thereafter. It also means that inflation will have been outside the top of the target band (1% to 3%) for more than a two year period.

Inflation remaining stubbornly high is a key reason why Cebr now believe that it will be difficult to achieve rapid GDP growth in the medium term. Cebr has revised up its forecast for GDP growth in 2012 from minus 0.4% to plus 0.3%, but in the medium term growth is forecast to average just over 1% per annum for the whole period to 2016.

Public borrowing is forecast to only fall to £90 billion by 2016/17 because of the impact of sluggish growth on tax revenues.

Unemployment is forecast to rise to about 3 million and stay there for at least 3 years.

Scott Corfe, Cebr Senior Economist and main author of the report comments: ”The Monetary Policy Committee has been dealt the worst possible hand of cards. High inflation and sluggish growth on a persistent basis mean that almost any decision the Committee makes will be wrong from at least one point of view. They will probably hold base rates for two more years at least and stop further QE. But even that may not be enough to keep inflation near target or get economic growth at a reasonable rate.”

Douglas McWilliams, one of the report’s authors and Chief Executive of Cebr, added: “Our growth forecast is not as miserable as our last forecast in January. But the inflation outlook is worse because of high oil and commodity prices.

“Inflation used to be driven by labour costs. Now it is driven by high and rising demand for oil and other primary commodities from the emerging economies in the Far East. We could only opt out of this by pushing up the exchange rate to a level that made the UK even less competitive. So it looks as if inflation above target is a price we may have to pay for a period.

“The Chancellor made announcements in the last Budget which could help escape from stagflation with proposals for lower top tax rates, revised planning procedures, more airport capacity in the South East and a more pro-growth energy policy. If these are followed through, there is the prospect of faster GDP growth than we are currently predicting. But with pervasive anti=business attitudes amongst the public and a weak coalition government we will need to be convinced that these proposals will actually be implemented sufficiently soon to affect growth. ”

Cebr was voted the best GDP forecaster for 2011 by 5 independent assessments.

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