OECD calls for world interest rates hike

Massive hikes in interest rates are needed across the world economy to curb the threat of rising inflation, a leading economic think-tank warned yesterday.

Central banks in Britain, the United States and Europe should act now to counter the impact of the global economic recovery, the Organisation for Economic Co-operation and Development said.

The warning came as a member of the UK's Monetary Policy Committee (MPC) called for a radical change in the way rates are set to take more account of the value of the pound. Sushil Wadhwani said it was hard to explain why sterling had risen above a level equivalent to three German marks against the euro.

In its authoritative economic outlook, the OECD said: "A tightening of monetary policy is expected to keep inflation low nearly everywhere." If monetary authorities ignore the surge in global demand, then interest rates will have to be raised higher in the long run as their economies overheat. "This could generate a disorderly correction in equity markets and . . ., a loss of confidence in the dollar," it said.

In Britain, the OECD said, inflation had so far been restrained by the strong pound. This had kept goods prices low, masking accelerating inflation in the booming services sector. "Such pressures may be harder to contain in the future," it said.

Mr Wadhwani argues the level of rates set to hit the inflation target should depend on the exchange rate and other asset prices as well as the bank's forecast for inflation. But Mr Wadhwani, seen as one of the prominent "doves" on the MPC, stopped short of calling for the chancellor to change the inflation target.

"I would argue that looking at asset price misalignments as well as our two-year-ahead inflation forecast might help the MPC fulfil the chancellor's remit more effectively than just looking at inflation forecasts 18-24 months out," he said in a speech at the London School of Economics.

"The rise of sterling against the Deutschmark in recent months has been quite difficult to rationalise," he said. While part of the pound's appreciation could be explained as a result of better UK economic performance, he said it was harder to see why it had climbed above DM3. Mr Wadhwani said his preferred approach would have led to interest rates being a little lower than they have been.

And if the lower borrowing costs did bring the pound down, this would also reduce the number of firms going out of business and keep the economy's level of capacity higher.

Mr Wadhwani's call for a change in the way the MPC operates will prove controversial with some of his colleagues, and is unlikely to be implemented swiftly.

The MPC must decide whether to hike rates next week.Meanwhile, the OECD appeared to back the Treasury on whether it had added to inflationary pressure by pledging billions of pounds to public services. Last month the International Monetary Fund criticised the Budget for being "regrettably pro-cyclical." The OECD praised the Government's public finances and said Labour had "created room" to spend on health and education.

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