European Economies: Bank of England Raises Key Rate to 5.75%

European Economies: Bank of England Raises Key Rate to 5.75%

http://www.bloomberg.com/apps/news?pid=20601087&sid=at0Y0pC5oSj0&refer=home

By Svenja O'Donnell


Mervyn King, governor of the Bank of England July 5 (Bloomberg) -- Bank of England policy makers raised interest rates for the fifth time since August and said they're concerned inflation will stay above their target, adding to investor speculation that another move is likely this year.

The nine-member Monetary Policy Committee increased the bank rate by a quarter-point to 5.75 percent, the highest since April 2001, the central bank said today in London. The panel, led by Governor Mervyn King, said in a statement that ``the balance of risks'' to price stability still ``lie to the upside.''

Inflation has held above the bank's 2 percent target for more than a year as a boom in London's financial services industry and rising home values powered the fastest economic growth in three years. The pound rose close to a 26-year high against the dollar after the decision.

``There aren't clear enough signs the economy has reacted to previous hikes,'' said Karen Ward, an economist at HSBC Holdings Plc, who left the central bank last year. ``We may see another hike as early as September.''

Royal Bank of Scotland Group Plc revised its rate forecast after the decision and now expects the benchmark to peak at 6 percent later this year. Today's decision was expected by 53 of 60 economists surveyed by Bloomberg News. The remainder forecast no change.

Futures trading shows investors expect the bank's main rate, already the highest among the Group of Seven industrialized nations, to rise at least once more.

Global Rates

The implied rate on the December futures contract rose as much as 4 basis points to 6.33 percent today. 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 for the past decade.

The pound, which touched $2.0207 yesterday, climbed as high as $2.0202 after the bank's announcement. It traded at $2.0137 at 3:08 p.m. today.

Policy makers around the world are raising rates to tackle the threat of accelerating inflation. European Central Bank President Jean-Claude Trichet said today that borrowing costs in the 13-nation euro region are still low enough to support growth after the bank kept its key rate at a six-year high of 4 percent, signaling policy makers may raise them again as soon as September.

The U.S. Federal Reserve said June 28 that inflation is still the ``predominant'' risk facing the economy. Iceland's central bank today kept its main interest rate unchanged at a record high of 13.3 percent. Bucking the trend, Indonesia's central bank today cut its benchmark for the 13th time since May last year.

King Push

In the U.K., King has led the push for higher rates. Overruled in a 5-4 vote at last month's meeting, he said June 28 there is particular uncertainty about whether companies are raising prices.

``The margin of spare capacity in businesses appears limited, and most indicators of pricing pressure remain elevated,'' according to the bank's statement today. ``The balance of risks to the outlook for inflation in the medium term continued to lie to the upside.''

Inflation reached a decade-high of 3.1 percent in March and the bank predicts economic growth will reach 3 percent this year, the fastest pace since 2004.

An index of factory gate prices stayed close to an eight-year high in June, a report by the Chartered Institute of Purchasing and Supply and Royal Bank of Scotland showed July 2. DS Smith Plc, a U.K. maker of paper and plastic packaging, said June 28 it raised prices after ``strong'' European demand.

Further Moves

``July's statement will reinforce expectations of further policy tightening,'' said Royal Bank of Scotland economists Geoffrey Dicks and Ross Walker today.

Both business and union lobby groups called on the bank to hold off on further rate rises.

``Rates are now at a level that will prove painful for hundreds of thousands of homeowners and manufacturing,'' said Adam Lent, head of economic affairs for the Trades Union Congress, which represents more than 7 million workers.

Ian McCafferty, economic adviser to the Confederation of British Industry, said the ``the medicine is starting to work'' to quell inflation and that another increase may be ``overkill.''

Higher rates will add to pressure on consumers shouldering a record 1.3 trillion pounds ($2.6 trillion) of debt. Chancellor of the Exchequer Alistair Darling said in a Financial Times interview yesterday he's concerned Britons who took out two-year fixed rate mortgages in 2005, when the bank rate dropped to 4.5 percent, will now be faced with higher repayment costs.

Debt Burden

For consumers with variable-rate mortgages, each quarter- point rate increase adds about 30 pounds a month to repayments on an average 25-year mortgage of 200,000 pounds, according to the Council of Mortgage Lenders. Payments on a loan of that size will be about 150 pounds more each month than they were a year ago.

Any signs of slowing growth will make it harder for advocates of further rate increases to win their case in coming months. Chief Economist Charles Bean, who argued against a rate increase last month, said on June 28 that he expects inflation to slow in the second half. Rachel Lomax said the same day policy makers should be wary of ``overdoing it.'' The Bank of England will publish minutes of this month's meeting on July 18.

Inflation slowed to 2.5 percent last month because of falling utility bills. Consumer confidence fell in June for the first time in six months, Nationwide Building Society said yesterday.

``They won't want to raise too quickly again,'' Paul Robinson, a currency strategist at Barclays Capital, said in an interview. It will be ``some months'' before the impact of rate increases to date can be assessed.