Bank raises interest rates

Householders were left reeling today after the Bank of England raised interest rates to 4.75 per cent.

It is the first time rates have moved in a year and commentators said the decision from the Bank's Monetary Policy Committee (MPC) was one of the most hotly debated for some time.

Although some analysts had forecast a rate hike, many believed the Bank would keep the cost of borrowing unchanged for the 12th month in a row.

Today's decision is likely to cost homeowners with an average £80,000 mortgage just over £12 a month. It comes in the week that major high street banks reported increasing provisions to cover bad debt levels, mainly on personal loans.

In a statement, the Bank said the pace of economic activity had quickened in recent months.

"Household spending appears to have recovered from its post-Christmas dip. Business investment growth and investment intentions have also picked up," it said.

The statement added that a hike was necessary to bring inflation back to target in the medium term.

In May, the Bank warned that inflation would be above its 2 per cent target in two years if it did not raise interest rates but the MPC had not appeared in a hurry to make a move.

Investec chief economist Philip Shaw said: "Today's move may be a surprise to markets but it reflects the strength of the economy over the past few months and the increase in inflation.

"Our view is that the MPC has made an early move which should prevent interest rates from being raised again soon, if at all."

In June, soaring gas and electricity bills drove inflation to its highest rate since Labour came to power in 1997. The Consumer Prices Index (CPI) rate of inflation leapt to 2.5 per cent - up from 2.2 per cent in May and ahead of economists' forecasts of 2.3 per cent.

In addition, recent figures indicated that the UK economy grew by more than expected between April and June.

The preliminary estimate of GDP showed a figure of 0.8 per cent for the second quarter, slightly higher than most City expectations and stronger than the 0.7 per cent rise seen in the previous two quarters.

David Kern, economic adviser at the British Chamber of Commerce, said the MPC has done nothing to support the UK's economic recovery by increasing rates.

"We believe the GDP growth of 0.8 per cent in quarter two gives a misleading picture of the recovery," he said.

"Moreover, the rise in inflation to 2.5 per cent reflects soaring energy bills which are more likely to weaken consumer spending than lead to an inflationary spiral of higher wages and prices.

"We appreciate that the MPC must make difficult choices but the correct decision would have been to keep interest rates on hold. In spite of the tentative signs of stronger UK economic activity, raising rates at this time could damage business confidence."

CBI director-general Richard Lambert - until recently a member of the MPC - said: "CBI member companies will be disappointed by this increase, but will hope that a modest rise now will remove the risk of a more significant increase later in the year.

"Today's decision was always going to be a close call, given the recent data for output growth and price inflation."

He said the Bank's quarterly inflation report - due next week - would explain how the Bank's thinking has changed, and what led to a decision that has come as a surprise to the markets.

The MPC is currently two members short, with only seven debating interest rates, following the departure of Mr Lambert to the CBI and the sudden death of David Walton last month.