Rates likely to rise again as house price respite ends

The City was last night braced for an imminent increase in interest rates after the Bank of England made clear that it had provided only a temporary respite when it left borrowing costs unchanged this month.

Minutes of the meeting of the Bank's monetary policy committee showed that all nine members voted in favour of leaving rates unchanged at 4.5%, but emphasised that further moves would be needed to prevent inflation breaching the government's 2% target.

The account of the MPC discussions held on July 7 and 8 revealed that the Bank was concerned about alarming the markets with a third successive rise in borrowing costs, but it noted that "it was likely that the repo rate would need to increase further".

With the economy growing strongly, the Bank expressed concern that there was little spare capacity remaining and that there were signs of inflationary pressure building up. It added, however, that it was prepared to wait for August - when the Bank's staff conducts its quarterly health check of the economy - before deciding on whether to move again.

"There was a risk," according to the minutes, "that an unexpected rate increase, in the absence of significant news on the month, might prompt an unwarranted re-evaluation of the committee's strategy by market participants."

Geoffrey Dicks, an economist at RBS Financial Markets, said: "The MPC took a breather in July. They could afford to do so since the rate hikes of May and June had got them to where they would have liked to have been at the time of the May inflation report. The August report is likely to show that rates need to be raised another 25 basis points [to 4.75%]." Analysts said tomorrow's release of growth figures for the second quarter would be crucial in next month's decision.

Although some believe the housing market is slowing following the four increases in rates since last November, the Bank expressed scepticism at the idea. Activity, the minutes said, had slowed before only to pick up strongly again, notably in the first six months of 2003.

David Pannell of Durlacher said the housing market bubble could be about to burst. "We continue to believe that low interest rates, high employment and supply constraints will not stop house prices. We reiterate our forecast of 30% falls in nominal prices."

Mr Pannell said a fall of this magnitude, far more severe than the gentle decline predicted by the Bank - would only take average prices back to the level of June 2002.