THE BRITISH economy is in danger of overheating if interest rates are not increased this year, which could lead to a new boom and bust cycle, economists warned yesterday.
The UK’s rapid recovery has pushed down unemployment so rapidly that there is little spare capacity left, according to Legal and General’s James Carrick.
If nothing is done to take the edge off this boom he fears wages will rise quickly, pushing up prices.
And if the overheating continues for too long it could result in a bust, with the economy stagnating in several years’ time.
His analysis runs counter to the Bank of England’s – it believes there is more slack left in the economy, and so does not expect to have to raise rates until early to mid-2015.
“The Bank is overestimating slack in the labour market, while politicians are desperately trying to reengineer a pre-election boom,” he said.
“The government has become impatient with the recovery, and poured fuel on the fire with the Help to Buy mortgage guarantee scheme.”
Instead of acting to increase interest rates this year, Carrick fears the Bank of England will only tighten policy once inflation is on the rise, by which point it will be too late and a crash may ensue.
By contrast, Carrick hopes that a small rate hike would slow the boom and avoid a bust, with unemployed workers having a better chance of finding work in a steady economy .
Economists at Fathom Consulting agree there is no spare capacity left and that inflation will begin to pick up.
“We would favour a modest tightening in monetary policy starting before the end of the first quarter next year, but more importantly a shift in fiscal policy focused on the housing market. This could be in the form of an immediate end to Help to Buy,” said Philip Lachowycz.
However, he does not expect this to happen before the May 2015 general election, indicating the Bank “will be taking risks with inflation.”