Sterling hits 26-year high on fresh rate fears

Sterling powered further above $2 to its highest in more than a quarter of a century yesterday amid fresh fears of aggressive interest rate rises to bear down on inflation.

Speculation that borrowing costs will have to be lifted from their current 5.25 per cent to 5.75 or even 6 per cent was stoked by news that two of the nine-strong Bank of England Monetary Policy Committee voted for an immediate rate hike at this month's meeting. The revelation sent the pound, which on Tuesday burst through $2 for the first time in 15 years, soaring to $2.0133 - a level not seen since June 1981.

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The minutes of the MPC's April meeting showed the arch-hawks Andrew Sentance and Tim Besley were worried about the upside risks to inflation - firm consumption, strong business investment and global demand, and healthy profitability.

They also fretted about firms' increasing ability to push through price increases. "So overall, demand pressures were likely to add to existing tight capacity pressures, slowing the reduction in CPI (consumer prices index) inflation in the short-term and adding to medium-term risks," the pair said, calling for an immediate quarter-point rate rise. But they were outgunned by their seven colleagues, who elected to freeze rates at 5.25 per cent for a third month. Among the majority were David Blanchflower, the US-based labour market specialist who had voted for a rate cut in March, and the Bank's Governor, Mervyn King.

The minutes, published a day after shock figures showed CPI inflation has leapt to a 10-year high of 3.1 per cent, revealed a three-way split on the committee.

In the first camp were Dr Sentance and Professor Besley. In the second were those (probably Professor Blanchflower and the Bank's Deputy Governor, Rachel Lomax) who felt there was no compelling case for a change in rates because there was still some slack within firms and in the labour market. And in the third were those who argued that there were inflation risks, but it was better to wait until May when the Bank's forecasts are revamped for its quarterly inflation report.

Analysts said the minutes reinforced expectations that the MPC will hike rates at its next meeting on 10 May, and possibly again in subsequent meetings. "Following the disappointing consumer and producer price inflation data for March, it is a stone dead certainty that the Bank will raise rates in May," said Howard Archer, chief UK economist at Global Insight.

"Indeed, there is some speculation that the Bank could lift rates by 50 basis points to 5.75 per cent, although we think this is most unlikely. But there is undeniably a very real possibility that rates will rise to 5.75 per cent in the second half of the year."

Adding to the hawkish tone were the latest figures on the labour market. The Office for National Statistics said claimant count unemployment fell by 9,200 to 910,800 in March, nearly twice the expected decline. Average earnings growth jumped to 4.6 per cent in the three months to February - the highest for nearly three years.

The earnings figures were boosted by bumper City bonuses. Stripping these out, earnings growth was steady at a benign 3.6 per cent. That said, a large proportion of bonus money will be spent, boosting consumption growth as well as house prices.

Other data painted a less robust picture of the labour market, however. The internationally-recognised International Labour Organisation report showed the number of people unemployed rose by 21,000 in the three months to February. Employment fell by 47,000 over the same period, the first decline since the end of 2005.