Interest rate warning after Brown's £43bn spending boost

The Bank of England has sounded a warning note that Chancellor Gordon Brown's £43 billion public spending bonanza could lead to higher interest rates later this year.

The Bank of England has sounded a warning note that Chancellor Gordon Brown's £43 billion public spending bonanza could lead to higher interest rates later this year.

Experts on the Bank's Monetary Policy Committee, which is responsible for setting rates, suggested the growth of public sector spending could fuel inflation unless action was taken to keep prices in check.

Any suggestion that rates could go up as a result of Mr Brown's three-year comprehensive spending review (CSR) would alarm industry, which fears a rise would drive the pound back up on the foreign exchanges, making it more difficult for exporters to compete abroad.

The concerns about the level of public spending among some of the nine MPC members are disclosed in the minutes of the committee's last meeting two weeks ago, which were published today.

Although they voted unanimously at that meeting to keep interest rates on hold at 6%, some members said a rate hike might be necessary later in the year in order to keep inflation "on track".

"Looking forward, given the likely increases in public spending over the next two years, private sector spending needed to slow further if the inflation target were to be met," the minutes noted.

They added that the recent apparent slowdown in the economy may be no more than an "unwinding" of the millennium effect, which boosted economic activity at the end of last year.

Treasury officials played down the significance of the comments, saying that the MPC had already made clear its view that the planned increase in public spending - which was outlined by the Chancellor in his Budget last March - would not have a significant impact on inflation.

Although the Treasury representative Gus O'Donnell did not brief the MPC on the details of the CSR, which was still being worked on at the time of the meeting, he assured them that the proposed spending increases were within the Chancellor's Budget "envelope".

"The MPC recorded their view in the last quarterly inflation report that the macro-economic effect of the Budget was unlikely to be large," a Treasury spokesman said.

"The minutes published this morning show clearly that the MPC was briefed that the spending plans would be fully in line with the Budget. On that basis they voted unanimously to hold rates steady."

Officials also pointed out that since the Budget, the MPC had had four opportunities to raise interest rates but on each occasion had voted for no change.

Since then however there has been a change in the composition of the MPC with the introduction of two new outside experts - Christopher Allsopp and Stephen Nickell.

In his first meeting in June, Professor Nickell - an expert in labour market economics - voted to raise interest rates and may have been responsible for raising concerns now about the level of public spending.

Concerns about inflation were heightened by the publication today of official retail sales figures, which showed an unexpectedly strong 0.7 per cent pick-up in volumes last month.