Don't assume that interest rates have peaked

Gordon Brown's political opponents were no doubt praying that the Bank of England's monetary policy committee would react to the spending increases announced in yesterday's pre-budget report by raising interest rates today. But the outcome of its monthly meeting was never in doubt.

The bank had been fully briefed in advance about the contents of the chancellor's statement and appears to have rightly concluded that it does little to change the benign outlook for inflation.

Increases in spending on pensions and concessions to motorists will add to demand pressures. But the amount distributed by the chancellor is more than outweighed by savings from lower-than-expected interest payments on the national debt, falling social security payments and higher-than-expected tax receipts, leaving the overall fiscal position as tight if not tighter than envisaged at the time of March's Budget.

Meanwhile, virtually all of the other economic indicators published since the MPC's last meeting in October have continued to point to unchanged policy, most notably the first estimate of GDP in the third quarter which showed output growth slowing to 0.7% from the previous 0.9%.

But it is probably still too early to conclude that the cost of borrowing has definitely peaked at 6%. After some very soft manufacturing data at the beginning of the month, financial markets have begun to price in a rate cut. However, the tightness of the labour market remains a source of concern to some members of the bank's monetary policy committee.

With unemployment due to fall below 1m in the next few months, they believe that it is only a matter of time before wage growth takes off. The new pay round at the turn of the year, which risks locking in the higher rate of inflation this year, is seen as a potential flashpoint. Until it is safely negotiated, there is likely to be continued uncertainty about the future direction of interest rates.

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