City sees rates rising by the year-end

INTEREST RATES are likely to start rising by the end of the year, say City analysts, even if the Bank of England's Monetary Policy Committee (MPC) does cut rates by a quarter-point this week. Opinion is divided on whether the committee will trim rates to 5 per cent or leave them unchanged.

Either way, on the eve of their monthly meeting the MPC's nine experts have won a vote of approval from a group of critics. The "shadow" MPC - 10 academic and City economists - says in a report out today that the level of interest rates is "in the right region". But they added that another small cut was desirable to "underpin therecovery in confidence".

Industry groups and unions still hope for further reductions. Ian Peters, deputy director-general of the British Chambers of Commerce, said: "We need a cut to 5 per cent. Beyond the summer we'll have to wait and see," he said. "Ultimately we must get our rates to European levels, but that must be consistent with achieving the inflation target."

However, concern is growing in the financial markets that inflationary pressures in the jobs market are starting to outweigh the downward pressure on prices and activity from the strong pound. With the danger of outright recession receding fast, the financial markets are starting to look ahead to rising interest rates by Christmas.

"I think the MPC will cut rates again before mid-year, and next week is as good a time as any," said Kevin Gardiner, an economist at Morgan Stanley. But he warned that labour costs in the UK had been picking up.

Not everyone agrees that rates must therefore rise. David Hillier at Barclays Capital said: "Rates can stay at their present level for quite a long time."

But latest official data showed earnings accelerating to 5 per cent in the year to February, partly due to a bonus spike. Public sector pay growth has climbed significantly in the year.

More worryingly, unit wage costs have picked up sharply, except in manufacturing. This suggests that despite the recent slowdown the economy is operating near its capacity limit.

This need not prevent a rate cut this week or later, however. The Bank's new forecast for growth, in its quarterly Inflation Report next week, is not expected to show much difference from the subdued prediction in the February report.

The exchange rate has climbed further from its February level, helping to reduce import prices and also subduing exports even further.