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Interest rate call over money supply worries; DIRECTORS' GROUP RAISES DOUBLE-DIP RECESSION FEARS.

Byline: RHODRI EVANS

A LEADING business body today urged the Bank of England not to raise interest rates at all this year.

Ahead of the Bank's Monetary Policy Committee's interest rate announcement at noon, the Institute of Directors (IoD) warned that to raise rates now would put the UK at risk of a double-dip recession.

Writing in the IoD's latest UK Economic Outlook, the institute's chief economist Graeme Leach warned that a weak money supply was holding back the recovery.

He noted that the key M4 measure of money circulating in the economy had grown by just 1.7% in the year to May.

"This performance contrasts with received wisdom that 7-8% growth in the money supply is consistent with trend GDP growth of 2.5% and hitting the inflation target of 2%," he said. "Consequently the sustainability of the recovery must be in question without acceleration in the money supply."

Some have argued that a rate rise is needed to bring down inflation, but the IoD expert warned that to raise the base rate now would be unprecedented.

"Broad money growth is now the lowest it has been on a sustained basis since modern statistics were first compiled," he said.

"In the near future banks need to contend with the legacy of the financial crisis and the tightening in bank capital rules under Basle 3. "Further pressure from provisioning for bad debt is also likely to erode capital over the 2011-12 period.

"In other words, we face a drawn-out process of flat money supply extending over years not months.

"Even if the banks raise capital from the non-bank private sector, this will reduce the money supply - because it will reduce the bank deposits of those who provide the capital.

"To raise interest rates at this stage in the economic recovery, when money supply growth is so weak, would be unprecedented...

over the past 25 years interest rates have only been increased when money supply growth was in double digits."

Robert Lloyd Griffiths, the IoD's director in Wales, reiterated the concerns raised by his economist colleague.

"There's much discussion about the need for a Plan B in fiscal policy. We think the opposite," he said.

"The biggest threat to the economy comes from near-zero growth in the money supply. Let's not make the mistake of viewing money as irrelevant to the economic outlook. In the wake of the financial crisis it is central."

The warning from the IoD came as further data emerged yesterday which strengthened the case for holding the base rates at its current low of 0.5%.

Wage inflation could prove a key justification for a rise in rates, but the latest KPMG/REC Report on Jobs revealed that recruitment consultants saw further weakening of pay pressures in June.

The report said that the rates of inflation of both permanent staff salaries and temporary and contract staff wages were only marginal.

However, inflation remains stubbornly high, fuelled by factors including higher world commodity prices and a weak pound.

According to the British Retail Consortium, shop prices in June rose by 2.9% compared with the previous year, with food prices rising by 5.7%. Last month's increase the fastest in the overall index since October 2008.

Month-on-month, prices rose by 0.5% in June, with food prices ahead by 0.6%, the same as May, while non-food product inflation rose by 0.5% compared with a decline in May.

CAPTION(S):

* A weak money supply is holding back the recovery, according to IoD chief economist Graeme Leach
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Title Annotation:Business
Publication:Western Mail (Cardiff, Wales)
Date:Jul 7, 2011
Words:590
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