Bank raises rates to 4%

The Bank of England today raised interest rates by 0.25% to 4%, increasing the cost of borrowing for the second time in three months following signs of a strong pickup in the economy.

Explaining its decision, the Bank said the world economic recovery had become more broadly based and growth in the UK in the second half of last year was above the trend. In addition, consumer spending and borrowing remained resilient, it said.

"Against that background, and despite inflation currently below the 2% target, the committee judged that an increase of 0.25 percentage points in the rate to 4% was necessary to keep inflation on track to meet the new target in the medium term," the Bank said in a statement.

The upward move was widely predicted by economists following a batch of economic data in recent days pointing to increasing economic momentum. House prices saw the biggest monthly gain in 15 months in January, the Halifax bank said yesterday, lifting the annual rate of house price growth to 16%.

Another report, from the Chartered Institute of Purchasing and Supply, yesterday said the services sector, which accounts for 70% of the UK economy, grew at its fastest pace since June 1997. The last time the services sector was expanding that strongly the Bank was in the middle of four consecutive monthly rate rises.

Today's interest rate move marks a turnaround from last month, when the Bank's monetary policy committee voted 8-1 to keep the cost of borrowing on hold. Only Sir Andrew Large, the deputy governor, favoured an increase.

He cited the continued strength in house prices as well as in consumption and borrowing, despite a rate rise in November. This week's data confirmed Sir Andrew's concerns. Despite November's increase in borrowing costs, the economy raced ahead in the last quarter of 2003 at its fastest clip in over three years, with the momentum carrying over into this year.

The meltdown in sales over Christmas did not materialise as feared as consumers left their shopping spree until the last minute, while consumer borrowing slowed only marginally since the rate increase in November.

Even the manufacturing sector has shown signs of bouncing back, with the Confederation of British Industry declaring last month the manufacturing slump to be over.

Industrialists, however, will not be happy at today's move, pointing out that higher rates could snuff out what is still a fragile recovery. Moreover, inflation, at 1.3%, remains well below the Bank's 2% target. But the Bank has predicted acceleration through this year as the economy picks up.

Damion Larkin, head of advisory services at the Share Centre said:"We are expecting rates to increase by another 0.5% by the year end. From such a low base any small changes upward is unlikely to lead to dramatic changes in overall sentiment. We were expecting interest rates to peak at 4% but we have revised our expectations in view of a robust performance in the housing market and consumer spending."