By Elena Vasquez

The National Institute of Economic and Social Research has urged the Bank of England to raise interest rates from 4% to 5%, warning that inflation may not return to the 2% target until 2030.

NIESR’s autumn report calls for sharper monetary tightening after the Bank raised its policy rate to 4% last week. The Westminster-based think tank’s analysis says the Iran war could produce sticky inflation, elevated borrowing costs and a potential £30bn spending test for Andy Burnham and John Healey.

Forecasts cited in the report suggest one further increase would delay inflation’s return to target for four years. That conflicts with the Bank’s mandate to achieve price stability over the medium term, a period it defines as roughly 18 months to two years.

What is driving NIESR’s warning?

The institute warns of second-round effects: higher inflation can feed into wage bargaining and create a spiral of price increases across the economy. Its central concern is timing. About three-quarters of UK workers will agree pay settlements with employers during the first three months of next year, just as inflation is expected to peak above 4%.

NIESR says those settlements could entrench inflation as people form price-growth expectations. Its analysis also identifies too little slack in the economy, a condition reflected in high unemployment or low numbers of job vacancies.

The Monetary Policy Committee has previously warned that higher unemployment and fewer available jobs would weaken workers’ bargaining power. Policymakers therefore treat the interaction between the labour market and price-setting as central to deciding whether to raise rates again.

What did the Bank forecast?

In last week’s forecast update, the Bank said inflation would peak at 4.9% by July next year before falling to 2% in 2028. Governor Andrew Bailey said he could “see the argument” for another increase to 4.25% if energy prices remained higher and a larger inflation spike emerged in the coming months.

Those projections rested on a scenario in which President Trump ended the Iran war, Gulf trade flows resumed in the near term and Brent crude fell from $108 a barrel to about $75 by 2028.

Oil traded at around $90 a barrel on Tuesday after Trump said the conflict was effectively over. Despite that assumption, NIESR analysts remained more concerned about persistent UK inflation. They warned that the Bank’s rate-setters were “behind the curve” because two rate rises in total would not be sufficient to bring inflation back to target.

What would tighter policy cost?

In a scenario with interest rates as high as 4.75%, NIESR predicts about 0.4 percentage points would come off GDP growth in both 2028 and 2029. The UK economy would still expand by 0.5% in 2028, the institute says, but it argues an immediate move is necessary to prevent a larger hit to growth later while the inflation outlook remains uncertain.

Those rates would also complicate Chancellor John Healey’s efforts to keep public finances in order because the government would owe more in debt interest. NIESR calculates that Healey could miss his fiscal rules by up to £30bn if he tops up defence and care spending while allowing other departmental spending to grow in real terms.

The economists urged Healey to maintain fiscal tightening in the coming years. They also called on the Labour government and opposition parties to take a more realistic approach to spending cuts and tax rises, rather than prioritise a larger state or lower rates for households and businesses.

Recent governments have tended to top up budgets before spending reviews, a pattern that echoes warnings from the Office for Budget Responsibility.

When does the fiscal risk crystallise?

NIESR regards the 2027 Spending Review as the real test. It said the Budget failed to put public finances on firmer footing and deferred major policy decisions, leaving the government exposed if it seeks further spending increases.

The institute’s recommendation is a 5% rate and tighter fiscal policy, with the 2027 Spending Review the next decisive test for the government’s finances.