OECD warns over risks of raising interest rates

Updated: 

Interest rate setters face a "difficult balancing act" amid the threat of a potential housing market correction and risks to the wider economy from raising borrowing costs, according to an influential think tank.

The Paris-based Organisation for Economic Co-operation and Development (OECD) warned the UK was among a number of economies where sky-high house prices mean rate hikes could have worrying side-effects after years of rock-bottom borrowing costs.

Its comments come after the Bank of England signalled last week a rate rise may be needed in the "coming months" to ease surging inflation caused by the Brexit-hit pound.

Mark Carney
Bank of England Governor Mark Carney said any rates rises would be gradual and limited

The pound hit its highest level against the US dollar since the Brexit vote after last week's minutes of the Bank's September rates meeting hinted a rise could be on the cards as soon as November, although governor Mark Carney stressed in a speech on Monday that any increases would be gradual and limited.

In its interim economic outlook report, the OECD said: "Authorities face a difficult balancing act in continuing to provide support while managing financial stability risks."

It added: "In some advanced economies, including Australia, Canada, Sweden and the United Kingdom, house prices are elevated relative to rents, raising financial stability risks if rising interest rates were to trigger a housing market correction."

Rates have been at historically low levels in a number of economies - standing at 0.25% in the UK, where rates have not risen for more than 10 years.

"The long period of low interest rates has boosted asset price valuations and created financial distortions that will be testing to resolve," the OECD said.

Its report saw it stand by previous economic forecasts for UK gross domestic product (GDP), predicting it to slow from 1.8% to 1.6% for 2017, before dropping to 1% in 2018.

It said "uncertainty remains over the outcome of negotiations around Brexit" and cautioned over weak real wage growth, after inflation is taken into account.

"The depreciation of sterling has modestly improved export prospects but also pushed up inflation, dampening purchasing power and private consumption," according to the OECD.

It said the global outlook had brightened slightly since its June forecasts, with GDP growth expected to increase by 3.5% this year and 3.7% in 2018.

It had predicted growth of 3.6% in 2018 at the time of its last report.

But it cautioned that "strong and sustained medium-term global growth is not yet secured", with business investment and trade still weak and wage growth "disappointing".

Wage growth has become a major focus for policymakers in the UK as households have been squeezed by Brexit-fuelled inflation and paltry rises in earnings.

There are fears it will lead to a sustained pull-back in consumer spending, which could hold back progress in the wider UK economy.