Deputy governor promises action to curb inflation

Sir John Gieve, a deputy governor of the Bank of England, suggested yesterday that interest rates may have to rise again to curb inflation, thus strengthening still further the widespread market expectation of a rise to 6 per cent or possibly beyond by the end of the year. The pound rose to another 26-year high against the US dollar on the remarks.

Sir John said the Monetary Policy Committee, of which he is a member with a "hawkish" reputation, "will do whatever is needed" to push inflation back below its 2 per cent target. By June, it had run above that objective for the 14th successive month. The Bank raised rates to 5.75 per cent this month, a six-year high and the fifth rise in a year.

Raising interest rates too slowly "could compound the problems" of inflation, Sir John said. However, he added that "it's likely that rates are now on the restrictive side", possibly with one eye on yesterday's figures on output from the CBI. Although still relatively strong, orders edged lower, while manufacturers are the least confident they have been in seven months that they can raise prices (the latter indication of "pricing power" being one that is particularly closely monitored by the Bank).

Ian McCafferty, the CBI's chief economic adviser, said: "UK exports had been resolute in the face of a strong pound for a number of months but a combination of a slower US economy and sharp increases in the price of oil, commodities and freight is beginning to tell for exporters."

The Bank's policymakers will also have to deal with the aftermath of the two sets of floods that have hit the nation, although City economists were fairly clear that the macroeconomic effect need not be huge.

Marchel Alexandrovich of Dresdner Kleinwort estimates that "the cost of the recent floods could well rise to around £3bn". He added: "It will take some time to know what it will mean in terms of the impact on growth, but this sort of magnitude [around 0.3 per cent of GDP] is unlikely to materially impact the MPC's near-term decisions. The initial decline in output is likely to be made up by increased consumption and construction once the insurance payments come in." Other economists observed that the prices of some foodstuffs may be pushed higher, with a consequent knock-on effect for expectations of inflation.

The Bank's deputy governor also expressed concerns about developments in credit markets, especially the US sub-prime crisis and the impact of large sovereign funds, such as those from Singapore and China currently buying a substantial stake in Barclays Bank. "The switch of reserve rich countries from lenders to owners of financial or real assets is also likely to lead to political tensions and pressures for protectionism," Sir John said.

The Chancellor of the Exchequer, Alistair Darling, in his first major speech in his new role today, will resist calls for protectionism and emphasise the benefits of inward investment, while stressing that it should be a two-way trade.