Industry warns over half-point rate increase

Philip Thornton,Economics Correspondent
Monday 02 February 2004 01:00 GMT
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Business leaders fear the Bank of England will order a half-point rise in interest rates this week as a survey today shows confidence among companies is at a four-year high.

The CBI said it would "strongly object" to a 0.5 percentage point increase - which would be the first such move since 1995.

The City is unanimous in forecasting the Bank's monetary policy committee will raise rates on Thursday and the debate now is over how far and fast it will increase them from the current 3.75 per cent.

Digby Jones, director general of the CBI, the largest employers' organisation, urged the Bank to pursue a strategy that was "well-explained, well-signalled and gradual".

He said business "would not protest" at a quarter-point rise but added: "At this stage, we would strongly object to a half-point increase or any suggestion that rates might rise rapidly while inflationary pressures remain subdued. While there are many encouraging economic signals - not least a long-awaited recovery in the manufacturing sector - we cannot go too fast too soon."

The Bank has repeatedly said it will raise rates "gradually" if the economy grows in line with its forecasts. Last week, Paul Tucker, an MPC member, said this meant the Bank would act as inflationary pressures emerged.

Some in the City believe that might happen faster than the Bank expects. "The consensus and markets have not yet fully caught up with the explosive acceleration in UK and global economic growth," said Michael Saunders, an economist at Citigroup, who expect rates to rise above 5 per cent next year.

"Indeed, there is a case for a 50-basis-point hike rather than just a 25-point move, which would still leave monetary policy unusually loose."

The latest business survey from BDO Stoy Hayward, published today, showed business confidence and output had soared on the back of a recovery in the stock market, fast economic growth overseas and a surge in consumer spending. Its optimism index - which it said was an indicator of GDP growth two quarters ahead - rose to its highest level since early 2000.

Its output index had risen sharply on the back of growth in private and public services and now pointed to annualised growth of 3.4 per cent in the second quarter of 2004. This would follow annualised quarterly growth of 3.6 per cent in the final quarter of last year. Retail sales and consumer confidence surged in December.

However, inflation at 1.3 per cent is currently below the new 2 per cent target, while house price growth and consumers' appetite for borrowing may now both be slowing, according to the latest surveys.

Peter Hemington, a partner at BDO, said: "While we anticipate a rate rise this month, inflationary pressures remain low. This will make it difficult for the Bank to justify too many further increases this year."

Many City economists believe rates will peak at about 4.5 per cent this year. Ciaran Barr, the chief UK economist at Deutsche Bank, said in a report today: "While this will not be the last tightening, we continue to believe aggressive hikes are not necessary."

The key uncertainty is the impact on inflation and growth from the recent rise in the pound on the foreign exchange markets. Sterling is now 2 per cent stronger than the Bank had expected in November and last week Mervyn King, the Bank's Governor, said this was "something we have to take into account" - in terms of its impact on import prices.

There is added uncertainty from the rise in the euro, which Mr King said could slow economic growth in the rest of Europe, which is the UK's main trading partner.

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