Bank warns of interest rate rise

The Bank of England warned yesterday that a rise in interest rates was looming after it expressed concern about the impact on inflation of rising house prices, strong consumer spending and the recent weakness in sterling.

This week's lower than expected inflation figures and the falls in the stock market have probably ruled out an increase when the Bank's monetary policy committee meets early next month, City analysts believe.

But the minutes of the MPC's June meeting, released yesterday, provide evidence that an increase is in the pipeline, with only the timing now in question.

The minutes showed a 7-1 majority on the MPC in favour of keeping borrowing costs on hold at 4%, but the arguments in favour of the first increase in rates since February 2000 were "finely balanced".

Mervyn King, the Bank's deputy governor, backed a quarter-point rise in rates, arguing that inflation was on course to be close to 3% in two years' time, with the risk that it could be even higher. He said a modest increase would help rebalance the economy and act as a danger signal to homebuyers and consumers.

Mr King's vote was an embarrassment for the Liberal Democrat MP David Laws, who at last week's meeting of the treasury select committee accused the deputy governor of covering up his "hawkish" tendencies in order to further his chances of securing the top job at the Bank when Sir Eddie George retires, next year.

"I accept that he has dealt with any concerns," Mr Laws said yesterday. He said he had been "raising legitimate concerns".

According to the minutes, most members of the MPC felt that inflation was likely to remain below or close to its target for some time, removing the need for immediate action. But the committee expressed concern about the 3% drop in sterling against the euro, which will make imports dearer, and by the annual growth of 15%-plus in house prices.

The pound fell further on the foreign exchanges yesterday after Ed Balls, the Treasury's chief economic adviser, said the assessment of the government's five economic tests could be completed before the deadline of June 2003.

"He just re-raised the referendum issue," said Lee Ferridge, head of global currency strategy at Rabobank. "As soon as those words are mentioned the market takes a hit."

Sterling weakened by 0.15p to 64.20p per euro, a loss of more than half a percent on the day.