MPC mulled interest rate hike

The Bank of England's monetary policy committee (MPC) discussed the possibility of raising interest rates earlier this month but still voted unanimously to keep the cost of borrowing unchanged, minutes showed today.

Although all nine MPC members agreed to keep rates at a 48-year-low of 3.5%, some members said a rise in the cost of borrowing might "soon become necessary" because of the high level of consumption and household debt.

The minutes will reinforce sentiment in the City that the next move in interest rates will be up, and the only question remains that of timing - whether it will happen this year or early 2004.

"Although the decision to keep rates steady was unanimous it's clear that some members on the committee seriously mulled the idea of voting for a rate increase," Philip Shaw, chief economist at Investec, told Reuters. "We continue to feel higher rates are unlikely this year but markets will be very sensitive to any data relating to the household sector."

Bank minutes disclosed that MPC members were surprised at the strength of consumer demand in the second quarter. The revival of activity in the housing market, retail sales and the growth in household borrowing indicated that strong consumption had continued into the third quarter, the minutes said, indicating that consumption growth had been understated.

"If so, the stimulus provided to domestic demand by the current level of interest rates might prove to be more than was needed - given the projected recovery in external demand - to maintain prospective demand in line with the economy's supply capacity in the medium term," the minutes said, indicating that there are some second thoughts about July's interest rate cut.

The Bank surprised the City at the time, when Mervyn King had just taken over as Bank governor, by cutting rates to 3.5% as a precautionary measure to insulate the UK from a sluggish world economy, particularly in the US. Since then, there have been signs of a pickup in the US and Japan, although the eurozone continues to stagnate.

In the UK, growth is expected to mirror the US, with the economy picking up steam in the second half of the year after a feeble start. Recent data indicate that even the long-suffering manufacturing sector is finally showing signs of recovery - albeit a fragile one.

Manufacturers are no longer clamouring for a cut in interest rates and are instead warning against a premature rise in the cost of borrowing. Meanwhile, the UK jobs market remains buoyant with today's labour report showing a new record in the number of people in work.

Although economic growth has picked up in the US, the MPC wondered about its durability, pointing out that recent strength in consumption might be partly only the temporary effect of tax cuts and rebates.

The Bank also referred to subdued consumer confidence because of the uncertainties in the labour market. Meanwhile, the outlook for investment was also unclear, the committee noted, as the recent recovery might reflect delayed replacement investment, rather than investment in new capacity.

Another cause for concern was the rising US budget deficit - which is expected to exceed $500bn (?313bn). The large budget gap, MPC minutes said, might eventually put upward pressure on long-term interest rates, something that could jeopardise recovery.