BoE effects surprise interest rate hike

The Bank of England unexpectedly raised its benchmark interest rate by a quarter-point, the third increase since August, as policy makers said inflation may rise further and spur demands for higher wages.

The nine-member Monetary Policy Committee lifted the repurchase rate to a five-year high of 5.25 percent today, surprising all of the 52 economists in a Bloomberg survey. Risks of faster inflation ``now appear more to the upside,'' the bank said in a statement. The pound rose and bonds fell.

``It's a result of bank being very worried about the January wage round,'' Roger Bootle, an economic adviser to Deloitte & Touche LLP who formerly advised the Treasury on interest rates, said in an interview. ``Another rise in on the cards and there may be more after that.''

Inflation accelerated to 2.7 percent in November, the fastest in at least a decade. Policy makers including Governor Mervyn King have said they're concerned that rising prices will lead to higher wages. The last two rate increases have yet to cool the property market, where prices rose 10 percent last year.

The pound leapt the highest since June 2005 against and rose to $1.9510 versus the dollar from $1.9331. The benchmark FTSE 100 Index lost as much as 0.4 percent from yesterday, erasing earlier gains, as shares of homebuilders fell. The yield on the two-year gilt, which moves inversely to prices, rose to 5.37 percent from 5.25 percent yesterday.

``The margin of spare capacity in the economy appears limited,'' the bank said in a statement today. ``It is likely that inflation will rise further above the target in the near term. Relative to the November Inflation Report, the risks to inflation now appear more to the upside.''

Today's move marks the second time in a year in which the Bank of England has bucked expectations. In August it raised the rate for the first time in two years, a decision predicted by just eight of 46 economists.

This was the first time since 2000 that the bank raised rates in January. At that time, the economy was growing at a 4.3 percent annual pace and the FTSE stock index was near a record.

Now, rising utility bills and higher train fares are pushing up inflation as service industries, the biggest part of the economy, are expanding at their fastest pace in a decade.

``It's a stunning move,'' said Steven Bell, an economist at hedge fund GLC Ltd. in London. ``They're saying inflation is high and they won't take risks. They're clearly indicating that this is not the end now.''

Criticism of Decision
Lobby groups criticized the decision, saying policy makers had room to wait before moving. ``We believe that the clear risks that growth may slow sharply in both the U.S. and the euro zone should have been taken more fully into account,'' said David Kern, economic adviser to the British Chambers of Commerce.

Adam Lent, head of economics at the Trades Union Congress said the decision ``smacks of panic rather than considered judgment. There is not enough evidence to justify an increase in rates, which will be damaging for industry.''

Britain's benchmark rate now matches that of the U.S. The Federal Reserve raised borrowing costs 17 times to bring its benchmark to 5.25 percent in June and has kept it on hold ever since. The European Central Bank last lifted rates in December to 3.5 percent. All 35 economists in a Bloomberg survey expect the ECB to keep its benchmark rate unchanged at 3.5 percent today.

Inflation Forecasts
In November, the Bank of England forecast that inflation would return to target by the second half. Consumer-price inflation quickened to 2.7 percent that month, the fastest since the index was introduced in 1997. That report raised concern that workers will demand more pay from employers beginning this month.

UK rate setters will probably have seen an estimate of December inflation, which the statistics office publishes January 16, said Geoffrey Dicks, chief U.K. economist at Royal Bank of Scotland Group Plc.

That report may show inflation above 3 per cent, a level that would require Governor Mervyn King to write an open letter to the Treasury explaining what is being done to keep price increases within a point of the 2 per cent target.

Almost two-thirds of U.K. pay deals are struck between January and April, according to Incomes Data Services Ltd., a London-based consultant. King said on Nov. 30 that the bank is watching pay for signs of faster inflation.

``With inflation rising, employees will obviously like to see higher wages to ensure that their spending power is maintained,'' Ken Mulkearn, the editor of IDS's pay reports, said in an interview. ``Our initial snapshot shows that the median pay settlement in January was higher than the median in December.''

Quicker Growth
The economy expanded at 2.7 percent in the third quarter, most in two years. Growth in service industries such as banking and travel, which account for about two-thirds of gross domestic product, accelerated last month, an industry report showed.

Manufacturing, which makes up about 15 percent of the economy, rose for the first time in three months in November as faster growth in Europe boosted demand for British goods. Factory output rose 0.3 percent, the statistics office said today.

Record consumer debt and falling household confidence may help keep a lid on inflation. Britons owe a record 1.3 trillion pounds ($2.5 trillion) to creditors, bank figures show. The rate increase makes many mortgages more expensive to pay off.

Each quarter-point rate increase raises the monthly payment on a 150,000-pound mortgage by about 23 pounds, Nationwide Building Society estimates. Consumer confidence fell to a two-year low last month, a survey for Nationwide Building Society showed January 10.

Concern for Consumers
"We are already seeing a rapidly growing number of people falling behind with mortgage payments and in some cases threatened with repossession,'' Peter Tutton, policy officer at Citizens Advice, a consumer debt counseling service.

The unemployment rate, based on the International Labor Office measure, rose to 5.6 percent in September from 4.7 percent in August 2005. That didn't stop average wages from growing 4.1 percent in the three months through October from 3.9 percent in the quarter to September. Pay is the focus of the bank's concern.

"Pay growth is approaching danger levels,'' said George Johns, an economist at Barclays Capital in London. ``Economic growth will support housing in the medium term, and the bank is taking note of the upside risk to consumption.''

Home prices rose 10.5 percent in 2006, according to Nationwide, the country's third-biggest home-loans' provider. Prices are likely to keep rising this year even with higher interest rates, underpinning consumer spending, banks and economists predict. Nationwide predicts a 7 percent gain and HBOS Plc forecasts 4 percent growth.

Futures
Investors were betting on a rate increase by the end of the first quarter, futures trading suggests. The implied rate on the interest-rate contract maturing in March was 5.52 percent at 11 a.m. today, up from 5.32 percent on Dec. 1. The contract settles to the three-month London inter-bank offered rate for the pound, which averaged about 15 basis points more than the central bank benchmark rate for the past decade.

The decision ``will result in stagnation and prevent existing homeowners from moving up the ladder,'' said Philip Davies, chief executive of house-builder Linden Homes. "Consumer confidence will be dented by this latest rise, implying the continuation of an upward trend in interest rates into 2007.''