Bank says interest rate must rise

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Interest rates will have to rise if the Government wants to hit its inflation target, the Bank of England told Chancellor Kenneth Clarke yesterday - and the sooner the better.

The Bank's starkest warning so far about the need to raise the cost of borrowing as the economy forges ahead came as a blow to Tory hopes of the return of the "feelgood factor" with a further interest rate cut ahead of the election.

Ministers hailed an ICM poll narrowing the gap between Labour and the Tories as evidence of political revival fuelled by economic recovery. But Labour said the poll, in the Guardian, showed Labour's support steady at 45 per cent - enough for a landslide victory greater than Attlee's in 1945.

The Chancellor was accused by the Liberal Democrat spokesman Malcolm Bruce of putting the political interests of the Tory Party before the country. "Instead of overstimulating the economy now, Ken Clarke should be attempting to lock low interest rates and low inflation," he said.

There will be clashes between Eddie George, Governor of the Bank of England, and Mr Clarke in the coming months, City experts predicted yesterday. Businesses urged the Chancellor to ignore the Bank's warning and leave rates well alone.

But Treasury minister Michael Jack played down the difference of opinion between Mr Clarke and Mr George. "The Chancellor has always made it very clear that having got down to low levels of inflation, he is not going to give up that prize easily," he said.

Chief economist Mervyn King made the Bank of England's views plain: "The question will be when to raise int- erest rates." However, inflation is likely to fall from its current 2.8 per cent in the short term.

He added that it would be preferable to raise base rates sooner rather than later. "The longer we leave it, the further they will have to move."

Asked if he thought Mr Clarke would agree, Mr King said: "I rather imagine he would not wish to join the club of Chancellors after whom excessive booms have been named."

The Bank's quarterly Inflation Report predicted that with no change in policy there is a worse-than-evens chance of inflation staying below its 2.5 per cent target in two years' time. The outlook was worse than in the May report because the Chancellor had cut a quarter point from base rates in June, against the Governor's advice.

Yesterday's report also warned that the Government is running too big a budget deficit. It said high borrowing requirements "cannot be reconciled with hitting the inflation target as well as maintaining a sustainable fiscal position."

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