The 0.5 per cent increase, announced after a meeting between Kenneth Clarke and the Governor of the Bank of England, reflects the Government's determination to head off further increases in inflation and preserve its hopes of cutting taxes before the next election.
After growing by over 4 per cent last year, the economy is now beginning to push up against its productive capacity, creating a renewed risk of inflation, according to both Treasury and Bank officials.
Mr Clarke has decided that the need to counter that danger outweighs the extra costs that higher interest rates will impose on both British industry and homeowners.
The rise in base rates to 6.75 per cent means that interest rates have returned to their highest level in just over two years.
While most analysts agreed yesterday with the Chancellor's argument that an interest-rate rise now would prevent bigger increases in future, the majority predict another two base-rate increases this year, taking the level to 7.5-7.75 per cent.
Mr Clarke said: ``The UK recovery is one of the strongest in Europe and our inflation rate is below the average. I am determined to maintain sustainable growth and low inflation."
The increase was needed to keep inflation under control, he said, even though there were signs that the pace of the economic recovery had begun to moderate.
In the House of Commons, the Prime Minister, John Major, defended the rise. ``What would be most damaging for homeowners would be for inflation to take off in the way it has done in the past," he said.
Some business groups also criticised yesterday's action. While the Institute of Directors welcomed the short-term pain for the sake of long-term gain, the Confederation of British Industry said it was not needed.
Representatives of small businesses and the construction industry were particularly bitter. Richard Brown, deputy director general of the British Chambers of Commerce, said: ``Companies are struggling as it is to keep themselves in business.''
Sir Brian Hill, president of the Building Employers Confederation, said: ``A further rise in interest rates was the very last thing needed at such a delicate stage of recovery."
Brokers predicted that the average variable mortgage rate will rise to just under 9 per cent by the end of next month. Banks and building societies widely condemned the Chancellor for delivering another damaging blow to the housing market, but all refrained from an immediate mortgage rate rise.
Brokers warned, however, that the battle to maintain market shares in the middle of a fierce mortgage-price war, and the need to attract savers with higher savings rates, would lead inevitably to a break in ranks, probably by the spring.
"Everyone is playing a game of cat and mouse,'' said Simon Tyler, director of Chase De Vere Mortgage Management. The mortgage rate has risen by an average of 0.7 per cent in the last 12 months, while base rates had moved 1 per cent even before yesterday's increase.
Publicly, the big lenders played down suggestions of a stampede to raise rates. But privately some feel that the truce will hold for six to eight weeks before someone makes a move. The Nationwide Building Society said: "This obviously puts pressure on mortgage rates".
A spokesman for the Halifax said: "We are disappointed to see a further 0.5 percentage point rise in bank base rates, but given the recent adjustment we have made . . . we see no immediate need to announce any further changes. However, we will clearly need to keep the situation under review."
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