Gilts and share prices rallied after the announcement just before noon. But the FT-SE 100 index closed off its highs but up 17.4 points at 3034.7. Gilts ended weaker, following international bond markets, while sterling was barely changed.
Interest rates have returned to their highest level for more than two years. Kenneth Clarke, Chancellor of the Exchequer, said: "I judge that, on the balance of risks, a further increase in interest rates now will help to keep inflation under control. That is the best way to ensure healthy economic growth, leading to a continuing rise in secure jobs and higher living standards." He and Eddie George, Governor of the Bank of England, agreed to yesterday's increase at their regular monthly meeting at the Treasury.
The Treasury and the Bank hope that the series of base rate rises since September will enable them to prevent a return to the traditional pattern of boom and bust in the economy. Mr George has said he does not expect interest rates to return to the peak levels of previous business cycles.
The announcement did not come as a surprise, especially after Wednesday's half-point interest rate increase in the US. Economic statistics published last month showed that inflation had risen at the end of last year while economic growth slowed down onlya little. Almost all City analysts expected an interest rate move either this month or next. One of the most influential indicators was a recently-published Confederation of British Industry survey showing that industry had record order books while manyfirms were planning to increase prices in the next four months.
The Treasury's monthly monetary report, published yesterday, said that economic indicators since the previous meeting were mixed. Some pointed to a moderation in the pace of growth; others showed a more buoyant picture.The Bank's next quarterly inflationreport, assessing inflation prospects, will be published on Wednesday.
Mr Clarke said he had not been pushed into the move by Mr George, although he had recently said interest rate expectations were exaggerated.
Although they judged that action was needed, many in the business world criticised yesterday's rate rise. Richard Brown of the British Chambers of Commerce said: "We are seriously disappointed." He said many firms were struggling to stay in business. IanHandford of the Federation of Small Businesses said: "Expansion and investment are once again threatened by the Government's total failure to create economic stability and confidence."
The construction industry condemned the increase. The Federation of Civil Engineering Contractors reported yesterday that there were already signs of a downturn in the sector.
Mortgage lenders were also disappointed. A spokesman for Bradford & Bingley building society said: "This is another blow to a housing market that is struggling to recover. There is no spark of confidence."
The CBI's response was more measured. Howard Davies, director-general, said: "Conditions did not require a further rise." But he said there was no doubt the recovery would continue. The Institute of Directors welcomed the move, saying it was necessary tocontrol inflation - "public enemy number one" according to its director-general, Tim Melville-Ross.
Outlook, page 33