Pound drops as Bank raises base rate

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The Bank of England's decision to raise interest rates by a quarter point yesterday sent the pound lower on the foreign exchanges and led many City economists to warn that further increases in the cost of borrowing would be needed before long.

Abbey National was the first lender to increase its mortgage rate, announcing a quarter-point rise which will add more than pounds 7 a month to the cost of a typical pounds 50,000 home loan. It is likely to be followed by Cheltenham & Gloucester and TSB, both owned by Lloyds Bank, today.

Other big lenders said they would keep their position under review for the time being, but most are likely to follow suit.

Business reaction to the Bank's decision, which had been widely expected, was at best lukewarm. Industrialists warned that rising interest rates would keep the pound painfully strong and damage exports.

Adair Turner, director-general of the Confederation of British Industry, "reluctantly accepted" the need for yesterday's action. But he said: "Further interest rate rises in the short term would be unwelcome."

The Engineering Employers Federation, which this week reported a sharp slowdown in export orders, "regretted" the move. Alan Armitage, head of economics, said: "If the pound rises further as a consequence, exports will suffer further."

Both the CBI and the British Chambers of Commerce said the Budget had not been tough enough, leaving it up to the Bank of England to cool the overheating economy. Ian Peters of the BCC said: "We are witnessing the results of a Budget in which political expediency took precedence over the country's well-being."

However, the Chancellor and Bank of England were careful to back each other's moves. Gordon Brown said: "The Bank of England has agreed with me that we must prevent a return to the cycle of boom and bust." Inflationary pressures had to be brought under control, he said.

The statement from the Bank's monetary policy committee said the combination of fast consumer spending growth and the further strengthening of the pound had "sharpened the dilemma" for monetary policy.

But new, higher estimates for the level of output and the growth of sales made an interest rate increase necessary, "notwithstanding the further appreciation of the exchange rate and the contractionary effects of the recent Budget".

Some City economists thought the Bank should have opted for a bigger rate increase yesterday. Disappointment at the quarter-point move was given as a reason for a drop in the pound yesterday.

It lost more than a pfennig against the German mark to end at just under DM2.97. Steven Bell, chief economist at Deutsche Morgan Grenfell, said: "This reflects the number of people who had hoped for more and decided to take profits."

Many in the City were predicting another rate rise next month, although this will depend on a series of economic figures due in the next few weeks.