Holiday buying binge adds to threat of higher rates

Shoppers went on a combined Christmas and millennium binge last month, raising fears that the Bank of England will deliver another blow to homeowners next month in the form of higher interest rates.

Retail sales surged by 5.3% last year - their strongest annual rate for more than two years - following a 0.6% rise in December, according to the Office for National Statistics. Although analysts believe a further rate rise in February is now inevitable, many now think rates could peak at lower levels than the market had been expecting.

Yesterday's sales figures showed that despite robust demand, fierce competition is keeping the lid on price pressures. "With retail price inflation still subdued, sterling at such strong levels, and no convincing evidence that growth is still accelerating in any meaningful way, forecasts that rates will eventually move to 7% and above are beginning to look too pessimistic," said Jonathan Loynes, UK economist at HSBC markets.

The minutes of January's MPC meeting where the committee put up rates by 0.25%, published yesterday revealed that while all nine members favoured higher rates, there was little support a larger increase. Only one member, Willem Buiter, favoured a 0.50% rise.

"There are few signs that even the more hawkish members believe rates need to rise very aggressively from current levels," said Mr Loynes.

December sales appear to have been significantly boosted by partying over the millennium which pushed up food sales by 1.8%. But despite bouyant demand, retailers found it hard to make price rises stick. The sales deflator which measures how fast prices are falling, fell by 1.5% in the year to December. Economists are puzzled by the combination of robust demand and weak price presssures.

"A bouyant consumer market in which prices should be up and not down will get a few people scratching their heads," said Neil Parker, at the Royal Bank of Scotland. The Bank of England's governor, Eddie George, said in a speech last night that the debate over interest rates was finely balanced.

"The monetary policy debate is a narrow one," Mr George said. "It is about just how strong the growth, just how high the employment and just how low the rate of inflation. It is as good a prospect for the economy as a whole as we have known for some time."

He acknowledged that the strong pound was proving difficult for sectors of the economy exposed to international competition but reiterated that the Bank could not protect exporters by lowering rates to take the heat off sterling at the expense of letting inflation lose in the rest of the economy.