High inflation here to stay, says leading forecaster

Households are facing a continued squeeze on their spending power after a leading forecaster warned that high inflation was here to stay.

The Ernst & Young Item Club, which uses the Treasury's model of the UK economy for its forecasts, estimates that persistently high inflation has already knocked almost 3% off UK growth in the last three years.

It expects inflationary pressures to peak over the summer and said it is unlikely the CPI measure will dip below 2.5% over the next four years.

While the UK economy is showing signs of recovery, the Bank of England warned last week that inflation is not expected to fall below its 2% target until late 2015. New figures on Tuesday are to expected to show that inflation stood at around 2.7% in April.

Despite the impact on household budgets, the Item Club said the Bank was right to stick to its guns by allowing inflation to overshoot and keeping interest rates at an all-time low of 0.5%.

Item's senior economic adviser Carl Astorri said the alternative scenario would have seen interest rates rise in 2011, choking off the recovery even earlier and adding an additional 625,000 to the dole queue.

Food prices have risen by nearly 40% since 2007, while businesses and consumers have also had to endure the impact of rising oil and commodity prices, a weakening pound and hikes to VAT.

The report warned that even once temporary factors, such as a rise in tuition fees, have fed through the system, underlying inflationary pressures will have started to build again.

As the UK economic recovery continues to strengthen, workers will have greater bargaining power to push for wage increases while businesses will be in a better position to grow their profit margins with price hikes.

Rising import prices from emerging markets are also set to continue, driven by increasing labour costs as their economies mature.

The squeeze on household budgets was highlighted last week in official figures showing wage growth of just 0.4% in the year to March, well below the level of consumer price inflation at 2.8%.

Astorri said: "High inflation has had a corrosive impact on the UK economy over the last three years, eating into household spending power which has taken its toll on the high street."