King's casting vote led to rate rise

MPC voted 5-4 for quarter-point increase. Economic growth fastest for two-and-a-half years

Deep divisions within the Bank of England's Monetary Policy Committee (MPC) were revealed yesterday as it emerged the decision to raise interest rates this month was pushed through by the narrowest possible margin.

The nine-strong MPC voted 5-4 to lift borrowing costs by a quarter-point to 5.25 per cent, the minutes of the meeting revealed. The Bank's Deputy Governor, Rachel Lomax, the chief economist, Charlie Bean, and the executive director, Paul Tucker, were joined by an external member, David Blanchflower, in voting to keep rates at 5 per cent, arguing the MPC could afford to wait.

But they were outgunned by the other five, who felt there was already sufficient evidence to justify an increase and no compelling reason to delay.

As Mervyn King, the Bank's Governor, is the last to show his hand, he effectively had the casting vote. It is the first time the Governor has used his casting vote to change policy - previously, both Mr King and his predecessor, Eddie George, elected to retain the status quo in the event of a tie.

Analysts said the knife-edge vote made another rate rise as soon as February unlikely. It also undermined the pound, which dropped back to $1.9689, after hitting a 14-year high of $1.9916 on Tuesday. "The fact that the Bank's chief economist, Charlie Bean, and the executive director in charge of financial markets, Paul Tucker, opposed Mr King suggests there are big divisions on the MPC," said Nick Stamenkovic, an economist at Ria Capital Markets. "The risk of back-to-back rate hikes has significantly diminished, but I wouldn't rule out one in March."

The rate-hiking majority were concerned about shrinking spare capacity and said inflation had been rising because it had been easier for firms to increase prices. "There was a significant risk that inflation would not fall back as quickly as the committee had expected in its central case in the November inflation report and little risk that an increase in interest rates would cause an unnecessarily sharp slowdown in activity," the minutes said. They also flagged up buoyant asset prices as an additional concern, and argued that an early rise in interest rates might prevent larger increases later.

The dovish quartet were worried that a January move would be interpreted as a knee-jerk reaction to December's strong inflation figures, which were boosted by volatile energy and food prices. Instead, they favoured waiting until February, when a move could be explained in the context of the quarterly inflation report, which sets out the MPC's medium-term projections. "An increase in the Bank rate this month ran the risk of prompting an excessive monetary tightening by shifting up market interest rates," they added.

Gavin Redknap, an economist at Standard Chartered, said: "It appears the split was mainly due to the timing of the move, rather than whether the move should happen at all. This really does throw open the debate as to the timing of the next quarter-point increase which still, regardless of the January vote, appears likely."

The minutes came as official figures showed the economy bowled along at its fastest pace for two-and-a-half years in the fourth quarter of last year. Gross domestic product - a measure of overall economic activity - rose by 0.8 per cent in the October to December period, up from 0.7 per cent in each of the previous four quarters. That took growth for 2006 as a whole to 2.7 per cent, in line with the 2.75 per cent prediction made by the Chancellor, Gordon Brown.

A breakdown of the data demonstrated the unbalanced nature of the economy, the dominant services sector expanding by 1 per cent while production industries, including manufacturing, shrank by 0.2 per cent.