Bank warns that spending could hit interest rates

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Economists at the Bank of England warned yesterday that the spending plans revealed by Gordon Brown could lead to higher interest rates.

Economists at the Bank of England warned yesterday that the spending plans revealed by Gordon Brown could lead to higher interest rates.

Experts on the Bank's Monetary Policy Committee (MPC) - responsible for setting interest rates - said sharp growth in spending could fuel inflation.

Minutes of its meeting on 6 July, which were published yesterday, showed that "some members" are worried that rates may have to be raised again later this year to keep inflation on track.

"Looking forward, given the likely increases in public spending over the next two years, private sector spending needed to slow further if the inflation target were to be met," the minutes said.

However, the Bank's nine-strong committee voted unanimously to keep rates on hold at 6 per cent, with another group saying that rates may have already been set too high.

The Conservatives seized on the comments, saying they showed the Chancellor had ignored the economic impact of his "spending splurge". Michael Portillo, the shadow Chancellor, said: "With the Government spending more, families and individuals will have to be squeezed if inflation is to be kept on target. The only way the Government could achieve this is through higher interest rates or further rises in taxation."

The Treasury played down the significance of the comments, saying the Comprehensive Spending Review contained no information that was not contained in the March Budget, since when the MPC had kept rates on hold.

Although Gus O'Donnell, the Treasury representative, did not brief the MPC on the details of the review, which was being worked on at the time of the meeting, he assured it that the proposed spending increases were within the Chancellor's Budget "envelope".

"The MPC recorded their view in the last quarterly inflation report that the macroeconomic effect of the Budget was unlikely to be large," a Treasury spokesman said. "The minutes published this morning show clearly that the MPC was briefed that the spending plans would be fully in line with the Budget. On that basis they voted unanimously to hold rates steady."

Officials also said that since the Budget, the MPC had had four opportunities to raise interest rates but on each occasion had voted for no change. Since then, however, there has been a change in the composition of the MPC with the introduction of two new outside experts - Christopher Allsopp and Stephen Nickell.

In his first meeting in June, Professor Nickell, an expert in labour market economics, voted to raise interest rates and may have been responsible for raising concerns now about the level of public spending.

The Bank's deputy governor, Mervyn King, and its chief economist, John Vickers, also supported a rate increase at that meeting.

Concerns about inflation were heightened by the publication yesterday of official retail sales figures. The Treasury also denied it had confused the public with its headline figure of £43bn extra spending. The Institute of Fiscal Studies, an independent body, said the true figure was £50.5bn, which was the difference between the total for departmental spending for this financial year and 2003-04, the last year for the Comprehensive Spending Review.

Although this figure was in the details of the Spending Review, the Chancellor chose a headline figure of £43bn, which was the increase between 2001-02 and 2003-04.