Expect the Bank to strike again on borrowing

ECONOMICS - THE WEEK IN VIEW

The Bank of England took advantage of its new independence and jacked up interest rates by a quarter of a percentage point to 6.5 per cent on Friday in a move designed to curb inflation.

The decision was taken "with the aim of meeting the Government's inflation target" of 2.5 per cent, the central bank said. The move "offers the best chance of achieving continued growth in output and employment at a sustainable pace," it added.

Even though underlying inflation has fallen to the Government's target level of 2.5 per cent in April, the bank is concerned that price rises will be higher in two years' time.

"Domestic demand pressure, the labour market tightening, as well as uncomfortably strong monetary growth, are probably the economic rationalisations behind the move," said Andrew Cates, economist at UBS.

"These are clearly risks to the inflation target at the moment and the wish to gain market credibility at the earliest opportunity may have been a decisive factor."

Friday's move is likely to be the first of several. Economists expect the Bank to raise interest rates twice more this year, by a quarter-point each time.

"Expect another 25 basis point hike in August or September," said James McKay, international economist at Paine Webber International.

This was the second rate rise in a month. Interest rates were last increased by a quarter-point to 6.25 per cent on 6 May.

"We're talking about pre-emptive action rather than leaving it to do too little, too late," said the Bank's Governor, Eddie George.

The Bank of England has also warned that billions of pounds in free shares given to millions of people from building societies converting to banks may produce a surge in spending, threatening a rise in inflation.

Mr George estimated the total value of the windfall shares at pounds 30bn to pounds 35bn. Last week the CBI estimated that around 15 per cent will be spent, pumping pounds 4bn into consumer spending.

The next focus in terms of policy tightening is the 2 July Budget, in which economists expect Chancellor of the Exchequer Gordon Brown to dampen consumer demand by raising taxes, possibly by pounds 2bn to pounds 3bn.

In the US, figures on Friday showed that the jobless rate fell to 4.8 per cent, the lowest in a generation. Average earnings are now rising faster than last year's inflation rate and Federal Reserve chairman Alan Greenspan could be under pressure to raise rates next month to choke off the threat of inflation.

There are some other signs that growth is slowing. Investors take the view that signs of a slowdown in consumer spending will be crucial.

Unemployment figures released in Germany on Friday showed the opposite trend. There the number of jobless is still rising, by 56,000 in April, swelling welfare payments and making it more difficult for the government to plug a hole in its budget in time for joining the single currency.

"It's very clear the situation is getting worse rather than better," said Peter Meister, an economist at BHF-Bank. Little improvement is seen before the end of the year. Copyright: IOS & Bloomberg