Big spend may bring rate rise, says MPC

The Bank of England yesterday issued a veiled warning to the chancellor, Gordon Brown, that after Tuesday's bumper boost to public spending any pre-election tax giveaways would be met with higher interest rates.

Threadneedle Street's rate-setting committee voted unanimously to keep interest rates on hold earlier this month.

However, the minutes of the monetary policy committee's meeting, published yesterday, revealed that the committee believes that private sector spending will have to slow down to offset the large increase in public spending if the Bank is to meet its 2.5% target inflation.

The nine-member panel had been given a sneak preview of the chancellor's public spending plans, and the minutes of its meeting revealed that some members feared higher government spending could increase inflationary pressures.

"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.

Opposition parties said this was a signal that the MPC would respond to any demand boosting tax cuts with higher borrowing costs.

"Their comments make it clear that any budget tax cuts before the election on top of the existing spending plans would force up interest rates and hit jobs," said Matthew Taylor, economics spokesman for the Liberal Democrats.

But the Treasury denied the minutes amounted to a warning, noting that the MPC had pencilled in a slowdown in its forecasts when it was already aware of the overall impact of Mr Brown's spending plans.

"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.

Interest rates could also be forced up by rising spending. Yesterday's retail sales figures for June, released by the Office for National Statistics, showed that sales jumped by 0.7% during the month - a far higher level than City analysts had been expecting.

"These data provide ammunition for those MPC members who felt further increases in the repo rate would ultimately be necessary to press for another policy tightening at the August MPC meeting," said James Carrick at ABN-Amro.

But the ONS said underlying growth in retail sales was "much the same" as that recorded in May.

Sales were up 0.3% in the three months to June compared with the previous three - a figure which smoothes erratic monthly movements. That was only slightly higher than the 0.2% trend rate recorded in May.

But some City economists thought rates might be cut - thanks to the MPC's doves.

"For the first time we are getting suggestions that interest rates should perhaps be coming down," said Ciaran Barr at Deutsche Morgan Grenfell.

Signs that the world's largest oil producer, Saudi Arabia, has jumped the gun and started leaking some of the production increase of 500,000 barrels that the oil producers' club Opec has promised the west should also help ease the fears of the monetary policy committee's hawks.

Higher petrol prices have a been a major factor pushing up inflation in recent months.

The news pushed down oil prices on both sides of the Atlantic. In late trading yesterday the September contract for Brent Crude was off 30 cents at $29.02 a barrel, while August Nymex crude was down 44 cents at $31.50.

Industry sources said on Wednesday that Saudi Arabia was making good on its unilateral pledge to lift oil output by 500,000 barrels per day by already opening the taps by half that amount.

"The extra 250,000 are available for customers right now," said an industry source familiar with Saudi oil policy.

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