Brown warns public sector on pay rises as rate cut prospects fade

Gordon Brown warned public sector unions yesterday not to seek inflation-busting pay rises as the Bank of England poured cold water on hopes of a festive cut in interest rates.

The Chancellor wrote to the public sector pay bodies telling them to assume inflation would hit the 2 per cent target - even though it has been above that for four straight months.

In a speech today, he will say he expects the Bank to ensure inflationary pressures from soaring energy costs are kept under control. He will tell the Institute of Directors his decision to hand independence on rates to the Bank had helped to conquer inflation. "I believe this system and this active mechanism will again prove resilient as we now tackle the threat posed by a recurrence of inflation at a global level," he will say.

Meanwhile, David Walton, one of the members of the Monetary Policy Committee who backed the August rate cut, echoed the concern over inflation. "If wage inflation does pick up, then clearly that would be something of great concern to the MPC," he said in a radio interview.

In his letter to the Pay Review Bodies, Mr Brown wrote: "It will be important to ensure public sector pay settlements do not contribute to inflationary pressure in the economy. To do so would risk converting a temporary increase in inflation into a permanent increase.

"The Pay Review Bodies should therefore base its pay settlements on the achievement of the inflation target of 2 per cent, rather than on the recent temporary rise in the rate of inflation."

Hopes of a festive rate cut vanished yesterday after the minutes of the MPC's meeting showed its nine members were unanimous in leaving the base rate at 4.5 per cent. The outcome was more emphatic than some in the City had expected. "The MPC is firmly in wait and see mode," Howard Archer, the UK economist at Global Insight, said. Minutes showed there had been no discussion of either raising or lowering rates. Instead the MPC sent a clear message that the future path of rates depended on the strength of Christmas spending and levels of wages deals in the new year.

It said there had been no signs that oil prices had raised pay claims or inflation expectations but added: "The committee [will] monitor these effects carefully [as] January is an important month for private-sector settlements." Before the minutes were published, Mr Walton said: "I think we are seeing some signs that the economy is recovering. Inflation is above target and we need to make sure that it comes back to target and so that means a steady course for interest rates at the moment."