Base rate nudged up amid fear of inflation

Soaring consumer borrowing and a resurgence in the housing market triggered the first rise in interest rates in nearly four years yesterday as the Bank of England moved to prevent the recovery in the economy pushing up inflation.

After cutting rates to a 48-year low of 3.5% only five months ago, the Bank said a "modest increase" of 0.25 percentage points was now necessary to keep inflation in line with the government's 2.5% target.

The widely expected decision won backing from Gordon Brown. In a rare public reference to the factors weighing on the Bank's decision, the chancellor told GMTV that the economy was likely to grow faster next year.

"If the Bank has to take action to maintain, and entrench, and lock in that stability for people, that's what I want to see happen," he said.

Consumer groups expressed surprise after the Nationwide, Britain's biggest building society, announced that 500,000 of its mortgage customers on its standard variable rate faced an 0.35 percentage point increase in borrowing costs as a result of the Bank's decision.

"When rates have gone up in the past they have used their advantage as a mutual to cushion borrowers," said Mick McAteer, a senior policy adviser at the Consumers' Association. "They ought to be setting an example."

Analysts said Nationwide borrowers would feel doubly aggrieved because the building society had only passed on 0.1 percentage point of the July quarter-point interest rate cut.

But Nationwide said its "base mortgage rate" would still be about 90 basis points lower than most of its rivals, which were last night still considering their response. Nationwide's base mortgage rate will rise from 4.54% to 4.89% from December 1, while the Halifax's standard rate would be 5.75% if it passed on the 0.25% percentage point increase.

A typical £80,000 base mortgage rate borrower with a repayment loan will see their monthly mortgage bill rise by £16.07, from £446.49 to £462.56. A typical £120,000 borrower with an interest-only loan will have to fork out £35 a month extra (from £454 to £489).

After months of warning consumers about the dangers of taking on too much debt, the Bank said it had been forced to act because household spending and the property market had failed to slow as it had expected.

"Underlying inflationary pressures are therefore likely to build gradually as demand strengthens and sterling's depreciation earlier this year feeds through," the Bank said.

Although traders were betting that the Bank is planning an aggressive campaign which could see borrowing costs reach 5% by the end of next year, industry leaders urged caution.

"The rise has come at the wrong time for manufacturing, British industry is struggling and should have been given more time to get back on its feet," said Ian Brinkley, senior economist at the Trades Union Congress.

"The Bank must resist pressure to increase rates again next time."

Stephen Radley, of the Engineering Employers' Federation, said there was a danger that the Bank's decision would push up sterling, adding to pressure on the fragile manufacturing recovery.

"Manufacturers will hope that this is not the beginning of a trend of increases which could force the patient into relapse," he said.