LONDON (Reuters) - Britain’s National Institute of Economic and Social Research said it expects the Bank of England to start a sustained rate-tightening cycle on Thursday, which will lead to interest rates peaking at 2 percent in 2021.
NIESR’s forecast is more hawkish than almost all the economists polled by Reuters last week, and comes a day before economists expect the BoE to raise interest rates for the first time in more than a decade.
Three months ago, NIESR brought forward its expectation for a first BoE rate rise to February 2018, at a time when most economists still expected the BoE to wait until 2019 before beginning to raise rates.
In September the BoE surprised markets by saying most of its policymakers expected to back a rate rise “over the coming months”.
BoE Governor Mark Carney said this largely reflected a weaker outlook for productivity - which has stagnated in Britain since the financial crisis and reduced the rate at which Britain’s economy can grow without creating excessive inflation.
Markets now see an almost 90 percent chance that the BoE will raise rates to 0.5 percent from 0.25 percent on Thursday.
However, most economists polled by Reuters do not see enough in the way of inflation pressures to justify raising rates now, and think a mix of muted price pressures and Brexit uncertainty make a further rate rise unlikely in 2018.
NIESR, however, on Wednesday said a weaker outlook for productivity meant the BoE needed to raise interest rates by 0.25 percentage points roughly every six months to keep inflation in check.
“Now that we have lowered our productivity growth forecast, we have also raised the interest rate (path). There is a risk of overheating,” NIESR economist Amit Kara said.
NIESR forecasts that consumer price inflation, which hit a five-year high of 3.0 percent in September, will peak at 3.2 percent before the end of the year.
But unlike the United States and the euro zone, Britain’s economy has underperformed over the past 12 months, with the weakest year-on-year growth in four years at 1.5 percent.
NIESR expects growth in 2017 as a whole to be 1.6 percent, picking up marginally to 1.7 percent in 2018 and 2019 and overall a shade weaker than it expected three months ago.
But it now expects productivity to grow by just 1 percent a year over the next five years. Higher rates are needed even if wage growth does not improve from its current rate of 2 percent, half its average before the 2008-09 recession, Kara said.
However, this outlook for growth and interest rates assumed Britain’s departure from the European Union would not lead to major economic disruption, he added.
Editing by Andy Bruce