Rates rise to six-year high of 5.5%

The Bank of England brought mortgage misery to millions of homeowners yesterday by raising interest rates to 5.5 per cent - the highest for six years.

The quarter-point increase - the fourth such move since last August - had been widely expected in the City after inflation surged to its highest for a decade in March. Some analysts warned that borrowing costs could be lifted again during the summer.

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In a statement, the Bank's Monetary Policy Committee said the underlying economic picture was one of steady growth, while credit and the money supply continued to grow rapidly.

"CPI [consumer prices index] inflation picked up to 3.1 per cent in March," the statement said. "Lower gas and electricity prices and weaker import price inflation mean that CPI inflation is likely to fall back to around the 2 per cent target in the course of this year. But the margin of spare capacity in firms appears limited and there are signs that businesses are more able to push through price increases. Relative to the 2 per cent target, the risks to the outlook for inflation in the medium-term consequently remain tilted to the upside."

Analysts pointed to growing company pricing power and the continued strength of the housing market as particular causes for concern on the MPC. The committee was given a preliminary forecast of the April inflation rate, published next Tuesday, before making its decision. It will set out its medium-term forecasts for growth and inflation in next Wednesday's quarterly Inflation Report.

Shares on the London Stock Exchange rallied briefly when news of the rate increase hit trading screens at midday on relief that the MPC had rejected calls for a chunky half-point hike. However, the blue-chip FTSE 100 index closed down 25.5 points at 6,524.1. The pound also fell, finishing 1.22 cents lower against the dollar at $1.9819.

UK borrowing costs are now the highest in the G7. The European Central Bank froze eurozone rates at 3.75 per cent at its meeting yesterday, while America's Federal Reserve kept US rates steady at 5.25 per cent on Wednesday night.

Reaction to the rise was mixed. David Brown, an economist at Bear Stearns, said: "The Bank of England has been caught napping and ended up behind the curve. They needed to do something exceptional, but this quarter-point rise is a middle-of-the-road gesture. In these circumstances, the BoE really needed to raise rates by a half-point."

Andrew McLaughlin, group chief economist at Royal Bank of Scotland, said: "If inflation turns down as I expect, then borrowers can probably rest easy in the knowledge that 5.5 per cent is as high as rates will go. If not, then the market forecast of one or two more hikes could come good. Borrowers should hope for the best, but plan for the worst."

A Reuters poll of 62 economists conducted immediately after yesterday's rate rise found 21 expect borrowing costs to hit 5.75 per cent this year, most likely in August.

Business groups were similarly split. Ian McCafferty, the CBI's chief economic adviser, said he "fully accepted" the need for the rise, but saw "no reason" for a further increase at present. However, Kevin Hawkins, the director general of the British Retail Consortium, described it as "bad news for hard-pressed consumers" which "may turn out to be unnecessary".

Before the rates announcement, official figures showed the manufacturing sector rebounded in March after a poor start to the year. Factory output rose by 0.6 per cent, the biggest one-month increase since last May. That still left output only 0.9 per cent higher than a year earlier.

Meanwhile, Britain's trade gap with the rest of the world widened more than expected in March as high-spending consumers sucked in more foreign goods. The trade in goods deficit rose to £7.048bn, up from £6.948bn the previous month and the highest since last May.

Housing market has spring in its step

The housing market is in the grip of a spring boom, Britain's biggest mortgage lender confirmed yesterday.

Halifax said the average price of a UK home leapt by 1.1 per cent to £196,745 in April. The annual rate of increase now stands at 10.9 per cent. Prices have risen by 5.6 per cent since the start of the year alone.

The bank played down the latest increase, pointing out that it was the smallest monthly rise this year. It said mortgage approvals had waned from the highs of last year, and that higher interest rates were hitting affordability. But analysts said the data showed the market remained in rude health. Last week, Nationwide also painted a picture of strength. According to its figures, prices rose by 0.9 per cent in April to stand 10.2 per cent higher than a year earlier.

Howard Archer, the chief UK and European economist at Global Insight, said: "The still-firm Halifax and Nationwide data for April reinforce our expectation that house prices will only gradually lose buoyancy over the coming months."

Martin Ellis, Halifax's chief economist, said demand remained healthy which, together with tight supply, continued to push up prices. "Good economic growth and a strong labour market will continue to support healthy housing demand," he said. "Negative real earnings growth and the increase in interest rates since last August, however, are expected to exert increasing pressure on householders' finances, resulting in a slowdown in house price inflation over the coming months."

Research from the Royal Institution of Chartered Surveyors showed house prices have soared by 170 per cent under Tony Blair, but the up-front cost of becoming a homeowner is more than three times higher. Affordability - the amount of income swallowed up in mortgage costs - has worsened by 82 per cent.

Jane Padgham