Interest rate decision on a knife edge amid growing inflationary concerns

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The Bank of England's depleted interest rate committee faces its toughest decision for a year, with the City split over the need for a hike to quell inflationary pressure.

Sharp rises in inflation and growth, combined with a fresh rise in housing market activity, have prompted several economists to switch their forecast to a rate rise on Thursday. Seven out of 46 polled by Reuters bet that the Monetary Policy Committee would raise the base rate to 4.75 per cent. Overall they put the odds of a hike at three-to-one.

The latest figures showed inflation jumped to 2.5 per cent in June, its highest since the series began in 1997, from 2.2 per cent in May. Economic activity accelerated to 0.8 per cent in the second quarter of the year, marking the third successive quarter of above trend growth.

Analysts warned that inflation could move higher yet in the wake of the price rises announced by British Gas last week that will affect 17 million households. From September, gas prices will rise by 12.4 per cent and electricity prices by 9.4 per cent. These followed the 22 per cent rise in gas and electricity prices this year.

Last week the National Institute for Economic and Social Research reiterated its call on the Bank to raise rates now, saying there was "little to be gained by delaying". However, it acknowledged that the fact that the MPC was two members short could stay its hand. The dilemma facing the Monetary Policy Committee is highlighted in a survey out today that shows an upturn in economic growth, but warns the outlook is less certain.

BDO Stoy Hayward, the accountancy firm, said its latest trends report found business confidence had hit an 18-year high on the back of buoyant demand from key export markets. But it added that concern over the continued US slowdown and Middle East conflict, combined with expectations of higher interest rates, would knock confidence.

And new figures out from Hometrack, a property consultancy, suggest the housing market is slowing again. House prices in July rose 0.6 per cent on the previous month, taking the annual growth rate to 3.2 per cent. For the first time in nine months the number of estate agents reporting price increases declined.

Roger Bootle, economic adviser at Deloitte, the accountants, said he thinks speculation of rate rises by the autumn is "premature". He believes pressure on UK interest rates will be down "if and when the US economy slows". Deloitte has eased its forecast for UK GDP growth for 2006 up to 2.5 per cent from 2.2 per cent, but expects a combination of spare economic capacity and intense competitive pressures to keep underlying inflation in check.

The MPC is still waiting for the replacements for Richard Lambert, who quit in March to become the director general of the CBI, and David Walton, who died in June. "The August decision will be a close call, with a 25 basis point increase looking more likely at this meeting than it has done at any time so far this year," said Nick Kounis at Fortis, one of those predicting no change.