Bank rate rise 'was mistake

The Bank of England has raised interest rates too soon, and the prospect of a further rise could push the consumer into serious retrenchment and the economy back into stagnation, says a respected economic forecaster.

Markets are keenly awaiting this Wednesday's release of minutes to this month's Monetary Policy Committee meeting. The minutes will reveal the strength of backing for the rate rise on the committee.

Economists are specifically looking for whether any of the MPC's nine members voted for a 0.5 per cent rise in rates rather than the 0.25 per cent agreed, which would suggest pressure for another rise next month.

But the Ernst & Young Item Club, which uses the same forecasting model as the Treasury, says that any further rise risks a grim Christmas for consumers and homeowners.

'The risk is that in tightening the monetary policy screw too early, the MPC will choke the life out of the fragile economic recovery,' said Peter Spencer, chief economic adviser to the Item Club.

Business groups have also warned the Bank against any further hikes. Confederation of British Industry leader Digby Jones said he could accept this month's rise as a 'nudge on the tiller to maintain HMS Stability. But all of business would be worried if it was the start of a sustained increase'.

The Item Club said that it is the effect on consumers that should most trouble the Bank.

'Although there have been encouraging signs in terms of a pick-up in the world economy and UK investment intentions, none of these are secure enough to survive the fall in consumer sentiment that will follow another premature hike in interest rates,' said Spencer.

Last week, Bank of England Governor Mervyn King warned Britons to think carefully about the amount of debt they can afford, given the prospect of changes in economic circumstances or interest rates. But King played down expectations that the economy could suffer from a 1990s-style housing crash.

'I would take cold comfort from an assertion that things won't be as bad as the early 1990s,' said Danny Gabay, an economist at Fathom Consulting. 'The Bank is now facing its sternest test - whether it can achieve a soft landing. And that will be difficult.

Many City economists thought that the minutes suggested a sustained increase in Bank base rates.

'The Inflation Report is a clear warning that base rates are likely to rise further in coming months. The MPC has upgraded markedly its growth and inflation forecasts over the next two years. In recent years, such changes have been a reasonable guide to subsequent changes in base rates,' said Michael Saunders, economist at Citigroup, who sees rates at 5.5 per cent by 2005.

But the CBI's Jones hoped that the rise to date would be sufficient: 'My take is that with Christmas approaching the Bank is saying to Mr Credit Card Holder, "if you add to the debt mountain, be aware that rates may go up, and if I were you I wouldn't do it", and I hope the general public gets the message,' he said.