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BDO Stoy Hayward’s latest quarterly Euro Area Business Trends report shows that the UK Inflation Index has leapt from 108.4 in October to 111.8 in January, the highest level recorded on the Index.

This reflects a weakening sterling and rising costs of oil, energy and food which firms plan to pass on to consumers, and implies consumer price inflation growing at an annualised 3.2 per cent in the first quarter of 2008. This would take inflation further above the Bank of England’s target.

This is in contrast to the Euro Area Inflation Index which has increased modestly from 101.4 in October to 101.9 in January, implying consumer price inflation of 2.2 per cent in the first quarter of 2008.

Credit crunch casts shadow across Euro Area

The ‘poll of business polls’ also shows that all four major economies in the Euro Area, France, Italy, Germany and the UK are continuing to feel the effects of the credit crunch.

France, Germany and the UK have all fallen below the neutral 100 on the BDO Output Index and Italy remains below 100, indicating below trend growth over the next quarter for each economy.

The UK Output Index fell from 100.8 in October to 99.8 in January, the first time the UK has fallen below 100 since January 2006.

This indicates growth in the first quarter of 2008 of 0.6 per cent.  Medium term confidence, however, as measured by the Optimism Index reveals that UK firms remain relatively bullish, expecting a downturn in 2008 to be relatively mild and short lived.

Divided opinions 

The UK Optimism Index crept up from 100.9 in October to 101.0 in January. This is in contrast to the Euro Area index which dropped from 99.6 in October to 99.1 in January.

This supports the view that the UK will outperform the major Euro Area economies in the first half of 2008, helped by a more expansionary interest rate policy and weaker currency.

Peter Hemington, partner at BDO Stoy Hayward LLP, said that opinions were divided over the best response to soaring inflation expectations and the economic slowdown.

“Our data suggests that, in contrast to the European Central Bank’s hawkish strategy, tackling short term nervousness with interest rate cuts is helping to maintain growth in the UK economy,” he added.

He said that the Bank of England was taking a gamble that inflationary pressures will ease later in the year as the economy weakens.

“It is nevertheless unlikely that the Bank of England will follow the Federal Reserve in making drastic interest rate cuts and we expect to see a quarter point reduction next week,” Hemington concluded.

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• BDO Stoy Hayward