King eases fears of surge in interest rates

The Governor of the Bank of England yesterday dampened fears of a sharp and sudden rise in interest rates, saying the UK was not in the grip of an "inflationary surge".

The Governor of the Bank of England yesterday dampened fears of a sharp and sudden rise in interest rates, saying the UK was not in the grip of an "inflationary surge".

Mervyn King said the Bank had already raised rates to a "more normal, sustainable level", adding that they would not have to rise by as much as in other major economies.

He also played down the significance of the debate at the monetary policy committee meeting in May over a half-point rate rise. But he indicated that rates had further to rise, saying that the British economy had little spare capacity to accommodate the growing pressures from the labour market.

Mr King, in his testimony to the House of Lords economic affairs committee, said: "We have raised rates to a more normal, sustainable level. What we have seen is not a great inflationary surge [but] some signs of a potential modest pick-up in inflation. It's a modest pick-up."

The Bank of England became the first of the world's four top central banks to begin lifting rates since the world slipped into recession in 2001. Rates are now 4.5 per cent.

Japan has cut rates to almost zero, the US Federal Reserve cut rates to a 46-year low of 1 per cent, while the European Central Bank has held its base rate at 2 per cent.

"I think it's pretty clear that the world interest rates cycle has turned," he said. "But the amount by which rates will have to rise [in the UK] is certainly less than in other economies because they are starting at rates close to zero and they have much further to travel."

He insisted the Bank was targeting medium-term inflation rather than house prices. "It would be self-defeating to do so [to target house prices]," he said. "If we tried to target nominal asset prices, we would lose our control over the price level, the inflation rate.

"The reason for the rise in interest rates that we've seen was not to cool the housing market, it was to meet the inflation target in the medium term."

He stuck by the warning he issued to homebuyers last week that the chances of a fall in house prices had risen. "It would be a foolish assumption to make that house prices will only go up," he told the peers.

In May, the Bank's monetary policy committee debated raising rates by a half-point for the first time in its seven-year life, triggering speculation the Bank was about to launch an aggressive offensive against house prices.

But yesterday one MPC member, Stephen Nickell, described a half-point rise in May as "out of the question", while Charlie Bean, the Bank's chief economist, and Marian Bell, another MPC member, felt it would send the wrong signal to the markets.

US prepares for rate rise,