Bank lifts rates and signals more increases to come

Cost of borrowing rises to 4.25 per cent as FSA chief warns banks over irresponsible lending
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The Bank of England yesterday sent a clear signal it will raise interest rates over the summer as it ordered the third increase in seven months to quell inflation pressure from rising house and oil prices.

The Bank of England yesterday sent a clear signal it will raise interest rates over the summer as it ordered the third increase in seven months to quell inflation pressure from rising house and oil prices.

The decision to order a quarter-point hike in base rates to 4.25 per cent ­ the highest level since October 2001 ­ was widely predicted and caused few ripples among business leaders, the housing industry or the financial markets.

The attention immediately shifted to the timing of the Bank's next move as analysts seized on a strongly worded statement that accompanied the decision. It said economic growth had been "at or above trend" while business surveys were "consistent with further strengthening".

"Retail spending continues to be robust, underpinned by income growth and unexpectedly strong house price inflation. Investment prospects have improved," it said. It acknowledged inflation was below target and likely to remain so in the near term, but said earnings growth had picked up and oil prices had risen sharply. "With a small and diminishing margin of spare capacity, inflationary pressures are likely to build despite a higher level of sterling than at the beginning of the year," it said.

Analysts said the tone was more "hawkish" than the statements accompanying its previous rate increases in November and February. "The Bank's comments were unambiguously hawkish," Paul Mortimer-Lee, the head of economics at BNP Paribas in London, said. "They are so one-way they may make the market fear the next hike will come earlier than our expectation of August."

The Bank's warning on oil came as crude prices came within a whisker of breaking the $40 barrier in New York, Tony Blair admitted he was concerned and rumours spread of a repeat of the fuel protests that brought Britain to a standstill in 2000. The price of oil in New York touched £39.97 a barrel, a fresh 13-year peak. The Prime Minister told reporters he had "a very keen interest" in surging oil prices. "This is something obviously we discuss with allies and partners and the oil producing countries ... because we have learnt from history that it can have a severe impact on our economy," he said.

Meanwhile, the Road Haulage Association said many of its members were unhappy. "Something is going to have to be done," a spokeswoman said.

Business groups gave a cautious reception to the rate rise, praising the Bank for signalling its intentions but warning it not to step up the pace of for fear of driving up the pound and hitting industry.

The CBI said companies were "pleased" the Bank had continued a "gradual" approach of raising rates every three months. "But with inflation well under control, firms would have serious concerns if this move were to herald the start of a series of more rapid hikes," Ian McCafferty, its chief economist, said.

The pound rose against the euro as the European Central Bank kept rates on hold, while London shares fell on fears of further rate increases.

An overwhelming majority of City economists had predicted the Bank would raise rates because of rising growth and inflationary pressures and a sequence of hints by senior Bank officials. But there was little agreement in the City over the likely path for rates, with forecasts for the peak in the cycle ranging from yesterday's 4.25 per cent to 5.25 per cent.

The City believes the Bank is communicating its intentions to the markets in a way it was reluctant to in the past. In a series of speeches, officials have said the Bank intends to raise rates "gradually" as long as the recovery stays in line with its forecasts.

So far it has chosen to act every three months to coincide with its quarterly Inflation Report ­ the next edition of which is published next week. It has also made clear it sees no benefit in trying to "shock" consumers out of their appetite for mortgage borrowing, insisting that it cannot target house prices.

Most mortgage lenders are expected to pass the full quarter point on to customers, with Abbey National and Cheltenham & Gloucester having already announced their variable mortgage rates will rise to 6.25 per cent from June. This will cost someone with a typical £100,000 mortgage an extra £15 a month.