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Interest rates must go up, warns leading think-tank

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UK interest rates will need to rise by the final quarter of the year at the latest, the Organisation for Economic Co-operation and Development (OECD) has said.

In its half-yearly report on the global economy, the OECD argued that the Bank of England should look to increase the official interest rate from its historic low of 0.5 per cent in the second half of 2010.

The move would be necessary to head off the threat of growing inflationary pressures.

The OECD also recommended that the Bank should begin to withdraw the £200 billion of quantitative easing that has been used to add liquidity to the economy during the recession.

Consumer Price Index inflation hit 3.7 per cent in April.

Although the Bank of England believes that prices will ease over the coming months, inflation has been on a stubbornly upward curve for nearly a year now.

In its report, the OECD said: “In response to the expected gradual rise in underlying inflationary pressure as the recovery gathers pace and to anchor inflationary expectations, the normalisation of interest rates and the scaling back of quantitative easing should start during the second half of 2010.”

The OECD forecast that the UK economy would grow by 1.3 per cent in 2010 and that consumer demand would be subdued.

Business activity would, however, gain a lift as firms look to re-build their stocks after depleting their inventories during the recession.

The report continued: “The recovery is gaining traction, supported by improving financial conditions, rebounding exports and a temporary surge to stockbuilding. High inflation and lingering effects from the credit crunch, together with necessary fiscal tightening, will nevertheless keep growth subdued in 2010.”

The OECD predicted that the UK economy would expand by 2.5 per cent in 2011.