Analysts read the half-point rise in base rates as a sign that there would be further increases this year.
The FT-SE 100 index ended 10.5 points lower at 3,128.8, partly reversing a steep fall in the morning.
Long gilts closed nearly a point higher but short sterling futures fell, indicating that traders expected a steeper profile of interest rate rises in the short term. The December short sterling contract suggested base rates at 6.75 per cent by the end of the year - an expectation that many economists said was an over-reaction.
Simon Briscoe, an economist at SG Warburg, said: 'Gilts will continue to benefit over the weeks ahead. The move will help loosen the market's deep-rooted scepticism that the Government is seriously prepared to tackle inflation.'
James Barty, of Morgan Grenfell, said: 'This rise was not just pre-emptive, it was jumping the gun. There is no great inflation surge out there but the Bank of England has clearly signalled that it will put rates up at the merest hint of inflationary pressure.'
The commitment boosted the long end of the market. Long gilt yields, like bond yields in other world markets, have risen sharply so far this year, in part due to expectations of higher inflation.
Nigel Richardson, bonds analyst at Yamaichi, said although traders were impressed by the Bank of England's early move some were concerned that it meant inflation prospects might be worse than thought. The August retail price index, out on Wednesday, would be closely watched.
Stephen Hannah, director of research at IBJ International, warned that gilts could still be vulnerable to developments in other markets. 'Gilts have been dominated by international factors and the US market is at a very difficult point,' he said. 'If it falls, gilts would not be decoupled.'
US Treasury bonds had a quiet start to the week as traders on Wall Street waited nervously for today's figures on consumer prices.
The stock market's welcome for the rate rise was tepid. Many analysts thought the move on reflection would boost share prices, but there was immediate concern about the prospects for corporate earnings. Alison Southey, at Nomura, said: 'This is going to be the first of many rises and we will start to see downgrades of earnings forecasts.'
Mark Brown, chief strategist at Hoare Govett, said company results so far this reporting season had been slightly disappointing. 'Rising interest rates are likely to inhibit profits increases,' he said, predicting that corporate earnings growth would slow from 16 per cent expected this year to 10 per cent next year.
Mark Tinker, a strategist at James Capel, said: 'The news should have been a plus for equities, but the market is in a fragile mood.' BTR's announcement last week that it could not pass on cost increases to its customers contributed to a fall in the stock market and Mr Tinker said traders were fearful of similar unpleasant surprises with the authorities so determined to squeeze inflation.
Sushil Wadwhani, equity strategist at Goldman Sachs, said that in the past interest rate increases had had no effect on the share prices after several months.
Some sectors would be hurt, however. These included any housing or retailing related stocks, since consumer confidence and the housing market were most vulnerable to higher base rates.
The interest rate rise was unambiguous good news for the pound, which closed up 2.78 pfennigs at DM2.41 and up 1.4 cents at dollars 1.566.
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