Bank of England warn of interest rate rise

Homeowners in the UK were today braced for an interest rate rise by the end of the year after the Bank of England revealed it would miss a key inflation target if it failed to act within a year.

The Bank said inflation would be above 2% in two years if borrowing costs remained at their current level of 4.5%.

But its quarterly inflation report reined in expectations that the Bank would soon ditch its wait-and-see approach, especially after gas and electricity prices surged since February and import costs grew at their strongest level for five years.

Bank governor Mervyn King said there were many risks around the forecast for inflation, including the impact of oil prices rising above 75 US dollars a barrel last month and whether there is any spare capacity in the economy.

Mr King said it was difficult to know precisely how the rise in prices of oil and other commodities such as metals will be passed through to consumer prices.

The Monetary Policy Committee (MPC) would be keeping a close eye on inflation expectations, which had picked up recently, Mr King said.

Although the change has been “small so far” it was important to monitor what is going on, Mr King said.

“If the rise were to persist then the committee would be concerned,” he added.

Although the City believes a rate hike in August alongside the next report is possible, most economists are pencilling in November as the most likely date for the next move on rates.

Malcolm Barr, of investment bank JP Morgan, said today’s report was more dovish than expected and “the data will need to significantly surprise the MPC if they are to move as early as in August”.

A rate rise was likely to take place in November, assuming there were sudden changes in the global economy, he said.

ING economist James Knightley said the likelihood of interest rates going up had increased, but a 0.25% hike could be enough to satisfy the MPC and bring inflation back on track.

Investec economist Philip Shaw said: “The Bank is uncomfortable with interest rates as low as 4.5%. It would need a run of subdued economic news over the next six months for the committee to keep rates unchanged.”

John Butler, analyst at HSBC, agreed.

“In the near term you require either big upside risks to GDP growth, a sharp rise in wage growth or even further strength in global demand to justify an early rate hike,” he said.

Mr King said house prices had recently risen more than the MPC had anticipated, but warned this may not carry on as prices were still “remarkably” high compared with average earnings.

The Bank said import costs are rising at their strongest rate for five years, while it noted surveys that suggest fresh recruitment drives by companies would take place in coming months.

The UK economy would continue to recover from its low point of last year as consumer spending picks up, investment recovers and trade provides a boost, the Bank predicted.

But its projections for growth were slightly weaker than in February when the Bank last published an inflation report. It is looking for a GDP figure of around 2.5% this year and 2.9% in 2007.