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Last Updated: Thursday, 11 January 2007, 14:20 GMT
Wage fears drive surprise rate rise
Nils Blythe
By Nils Blythe
Business correspondent, BBC News

There should be plenty of red faces in the City, after the Bank of England's decision to raise interest rates.

How rates have moved over the past year

Almost every single economist surveyed in the run-up to the monthly meeting of the Monetary Policy Committee confidently predicted that there would be no change.

So why have so many highly-paid experts got it wrong?

The most obvious explanation is that the Bank knows something which they don't.

Hard words

The official inflation figures for December are due to be published next Tuesday. The economists suspect that the Bank has seen data which suggest that there's been another sharp rise in inflation.

The last official figure for the month of November showed the consumer price index up 2.7% on the previous year. The official target is 2%.

While an official letter to the government would be embarrassing, what really worries the Bank at the moment are pay negotiations

If the rate gets to 3.1%, Bank of England Governor Mervyn King will have to write an official letter of explanation to the Government - something which has never happened since the Bank was given its independence in 1997.

The Governor may be feeling a little anxious. Inflation is almost certain to rise a further because of the huge increases in gas and electricity costs over the last year.

Pay up

But while an official letter to the government would be embarrassing, what really worries the Bank at the moment are pay negotiations.

Many large organisations settle pay increases at around this time of year. The Bank's concern is that the rate of inflation - especially on the broadly based Retail Price Index - will feed into large wage settlements.

That will put upward pressure on the prices which companies charge.

Danger signs?

And there is the awful possibility of a so-called "wage-price spiral".

Of course, in a globalised economy, many employers have little opportunity to pass on wage increases in their prices.

But like all central banks, the Bank of England is cautious and always alert to inflationary danger.

So will the latest move in interest rates be enough to cool the economy and bring inflation under control?

It will certainly bite in many households.

Some forecasters expect another rate rise in the coming months.

But as the Bank's latest announcement has shown, the forecasters don't always get it right - even in the very short term.

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