FALLING unemployment and rising average earnings are adding to pressure on the Bank of England will increase interest rates in the first quarter of 2007.
According to the latest Business Trends report from accountants and business advisers BDO Stoy Hayward, a tighter-than-expected labour market in the fourth quarter of 2006 is overheating the outlook for the first quarter of 2007.
The BDO Employment Index rose in the month of December from 107.8 to 108.4 - the highest level in more than 12 months, mainly down to part-time employees taking on temporary work over the Christmas period.
Plus large numbers of immigrant workers from Eastern Europe have also encouraged employment by restraining wages and providing a more flexible workforce. This trend is likely to continue following Romania and Bulgaria's entry into the EU at the start of the year.
However, Neil Craig, managing partner at BDO Stoy Hayward in Scotland, said: "Despite more immigrant workers pushing down wages, wage growth is being maintained.
"It's also forecast to rise this month with the latest pay settlement round, as employees push for large wage increases to counter higher inflation. With higher inflation and the expectation of wage increases, it's looking increasingly likely that the Bank of England will raise interest rates in the first quarter of this year.
"We could see the start of a vicious circle with bigger wage claims followed by rising interest rates. But while the Bank of England may increase interest rates in the first quarter of 2007 - a short sharp shock to address the current level of inflation - we expect this to be rebalanced later in the year."
Douglas McWilliams, chief executive for the Centre for Economics and Business Research, added: "Last year, we witnessed a strong performance from the UK's economy. Growth in 2007, however, looks set to be more slow and sluggish as rising interest rates tighten household finances and the world economy dips."
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