Oil spike may force rate rise, Bank deputy warns

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The Independent Online

The Bank of England may be forced to raise interest rates if commodity prices continue to rise, the deputy governor, Charles Bean, has warned.

The official line from the Bank's rate-setting Monetary Policy Committee (MPC), of which Mr Bean is a member, is that Britain's economic recovery is too fragile to withstand a rise in interest rates. Inflation running at 3.7 per cent in December and set to go higher will come back down to the 2 per cent target in 2012, the Bank says.

But in the face of global pressures, including rising food prices, metals and other commodities at record highs, and oil breaking through the $100 mark in response to concerns over stability in the Middle East, the MPC may be forced to raise rates regardless of the danger to the nascent recovery. "We may well have to respond to that by keeping domestically generated inflation lower," Mr Bean said in an interview with the Western Mail, a Cardiff newspaper.

The impact of a rate rise will depend on the situation in the wider economy, he said. "Whether it dents confidence depends on why it happens – if we raise rates because the economy is growing quite strongly and the recovery is entrenched then that's a 'nice' rise," Mr Bean said. "On the other hand if it is in response to a spike in oil prices that we think is likely to persist and inflation is becoming embedded, that's not a nice reason to raise interest rates, but we would have to do it."

Mr Bean's comments will add further grist to the debate at next week's MPC meeting. The group's newest member, Martin Weale, has already added his voice to that of Andrew Sentance – a long-term interest rate hawk – calling for rates to rise by a quarter of a point to 0.75 per cent to maintain the Bank's credibility as an inflation fighter. Meanwhile Adam Posen has called repeatedly for a further tranche of quantitative easing to prop up the stuttering recovery.

Mervyn King, the Bank's Governor, last week stressed with unusual candour the danger of raising rates before the economic recovery is strong enough to withstand the drag. And surprise figures showing UK GDP contracting by 0.5 per cent in the fourth quarter of 2010 give weight to Mr King's case. Even if the effects of the cold snap are discounted, growth was still only "flattish", experts say.

But the latest economic survey of the construction sector, published yesterday, adds to the evidence of a "two-speed" recovery to challenge the MPC policymakers.

The closely watched construction sector purchasing managers' index (PMI) jumped to 53.7 in January, from 49.1 in December, where a reading above 50 indicates growth. And new orders growth and business expectations climbed to a six-month andeight-month high respectively, says the survey compiled by Markit andthe Chartered Institute of Purchasing and Supply.

But economists warned that the index is still well below the level reached last spring, and at least part of the surge is the result of the cold weather that dragged activity down in December.

To add to inflation fears, construction groups also report spiking input prices. And the manufacturing PMI released earlier in the week reported record levels of activity and also record levels of input price inflation.