Debt fears put rate rises on hold

Christmas shoppers may be spared a rise in borrowing costs after the Bank of England said yesterday that it plans to proceed cautiously with further interest rate increases to avoid putting too much strain on debt-burdened households.

The Bank's nine-strong monetary policy committee voted eight to one to increase rates to 3.75% earlier this month, with one member, Marian Bell, preferring to keep rates unchanged. The minutes of the meeting, published yesterday, showed that the MPC was in no hurry to move again, despite City predictions that borrowing costs could reach 5% by the end of next year.

"Because of higher household debt burdens, there was increased uncertainty as to the strength of the response of consumption to any given interest rate change," the minutes noted. "It would therefore be appropriate to move interest rates cautiously."

The MPC cited the resurgence in the housing market, signs of revival in the world economy and revisions to the official figures showing stronger growth as the main reasons for the increase.

Most analysts believe further rate rises are likely at some point in the new year, after the Bank's latest inflation forecast published last week puts inflation above the government's 2.5% target for most of the next two years, even after the increase.

"Even after a modest rate increase, monetary policy would still be accommodative," the minutes noted, a clear hint, according to City analysts, of fur ther rate rises in the pipeline. Ms Bell, one of the MPC's external members, wanted to keep policy unchanged this month as she believed the MPC's central forecast for inflation was too high.

The cautious tone of the minutes suggested that the committee favours waiting to assess the impact of the first rise in borrowing costs in four years before taking further action.

"We can relax about December, especially as Tuesday's inflation data were unexpectedly benign," said Geoffrey Dicks, at the Royal Bank of Scotland. "Our forecast is for the next rate hike to come in February."

Households have built up record debts on the back of rising house prices, and the resulting consumption boom has kept the UK economy moving, even as other large economies have flirted with recession.

The Bank's goal now is to encourage consumers to ease off spending and repair their finances while businesses and government spending take over as the motors of economic growth.

"If rates were not raised, household borrowing would be more likely to continue to grow at a rate that would eventually prove unsustainable, and there would be a greater risk of a sharp downward adjustment to house prices if they became more overvalued," the minutes noted. Analysts said using higher rates to encourage consumers to cut back without tipping some overstretched households into financial difficulties would be a hard task for the MPC.

"We believe the Bank will raise rates only modestly on account of the impact of higher rates on the UK consumer," said Ciaran Barr, chief economist at Deutsche Bank.