Inflation to surge to 3.5% this year - think-tank

Inflation will rise this year to around 3.5% as the impact of the VAT rise kicks in – but the hike will be short-lived, says an influential think-tank.

In its latest forecast for the UK economy, the National Institute of Economic and Social Research ((NIESR) says CPI inflation will soon rise to 3.5% from 2.9% as the reversion of VAT from 15% to 17.5% feeds through to prices.

Such a development will see the Governor of the Bank of England write to the Government to explain what action it is taking to control prices.

But according to the think-tank, the rise in inflation will only be temporary, with the CPI measure averaging 1.7% in 2011.

"Underlying inflation has been raised by the depreciation of the pound, but the spare capacity that has opened up in the economy will bear down on prices, causing inflation to fall below the 2% target by the start of 2011," it says.

But the NIESR poured scorn on the Government's claim it will halve the budget deficit next year and said public debt will continue to rise.

"The plans for fiscal consolidation will not be sufficient to start bringing down net public debt as a share of GDP by the middle of this decade, as the Treasury expects," says the NIESR.

"Instead, it will carry on rising. Additional retrenchment will be needed through either extra spending cuts or fixed tax increases or a mixture of both."

It adds net borrowing will be around 6.8% of GDP in 2013-14 if the Government tightens public spending. But Chancellor Alistair Darling has vowed to reduce public borrowing to 5.5% by 2013.

Meanwhile, the NIESR expects the economy to grow by 1.1% and 2% over the next two years.

"Despite the disappointingly slow start to the recovery in the fourth quarter of 2009, we are expecting the economy to grow rather faster in the first three months of 2010 and beyond," it says.