Balls drives home Brown's message on public sector pay cap

Gordon Brown yesterday praised the Bank of England's decision to raise interest rates this month as he confirmed public sector pay deals would be capped at 2 per cent next year to prevent a fresh rise in inflation.

In his first comments since returning to frontline politics after the summer break, the Chancellor warned that the world economy faced an "uncertain future".

He said the Bank's decision to raise rates by a quarter-point - which took many in the City by surprise - was "forward-looking and pre-emptive".

Ed Balls, the economic secretary to the Treasury and Mr Brown's right-hand man, warned the UK faced the threat of further rises in inflationary pressure from soaring energy prices and rising gas and electricity bills.

"The issue is, can we take the tough long-term decision to ensure we keep our economy stable and growing [and] keep employment rising?" he said.

"It is extremely important that we keep a tough approach to pay in the public and private sectors as that's the only way we can keep interest rates low and keep our economy growing."

Mr Balls made comments in the run-up to the August rate decision that were seen in the City - certainly in retrospect - as giving a green light to an increase.

Economists in the City are growing increasingly worried that the Bank's Monetary Policy Committee will have to take further action to keep inflation from rising further above its 2 per cent target.

Michael Saunders, an economist at Citigroup, said the latest revisions to growth in the second quarter showed nominal GDP - growth in pure cash terms - was rising at its fastest pace for 12 years; and the deflators, a key inflation gauge, were on the rise.

He said headline inflation could "easily" rise above the 3 per cent level that would necessitate Mervyn King, the Bank's governor, writing a public letter to Mr Brown explaining the deviation. "This inflation overshoot creates big uncertainties for the MPC going forward," he said. "Our base case is for one more 25 basis-point hike to 5 per cent in November."

Stephen Lewis, the chief economist at Insinger de Beaufort, said: "Overall conditions in the labour market are not tight at present, but neither are they so loose as to support pay discipline. That is presumably why, ahead of the MPC's last meeting, Mr Balls signified approval of a more restrictive line on monetary policy."