Bank hints at UK rate increase

The Bank of England last cut rates in November

The Bank of England's rate-setting body has signalled that inflation may rise more quickly than previously thought, reinforcing expectations of an increase in interest rates.

(The report) by no means suggests that a hike is imminent,

Jonathan Loynes, Capital Economics

In its closely-watched quarterly inflation report, the Bank's Monetary Policy Committee (MPC) said economic growth is on track to reach an annual rate of 3% within the next two years, pushing inflation above the government's symmetrical target rate of 2.5% a year.

The MPC's latest growth and inflation projections, based on the assumption that interest rates remain constant at 4%, have both been revised upwards from its previous report, published in February.

The report reinforces the view that the next move in borrowing costs will be upwards, partially reversing a series of cuts beginning in February last year which trimmed base rates by a total of two percentage points.

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"The inflation report is much more hawkish than had been expected. This is the nearest the MPC comes to a tightening bias," said John Butler, economist at HSBC.

The MPC said that the UK economy hit a zero-growth trough during the tail-end of 2001, but is now picking up again.

It added that extra government spending and strengthening world demand are likely to stoke growth further in the months ahead, outweighing a slight decline in household spending.

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The nine-member panel said that while inflationary pressures remained benign, rising labour costs and stronger demand are likely to push inflation above the government's target rate towards the end of the next two-year period.

The monetary policy committee is charged with keeping inflation within one percentage point either way of the 2.5% target.

A sustained rise above 2.5% would increase the likelihood of an increase in interest rates.

"The Committee stands ready to act to contain any developing inflationary pressures further ahead," the MPC said.

Uncertain timing

However, some economists downplayed the prospect of an imminent rise in interest rates, pointing out that inflation is not projected to rise above 2.5% for nearly two years.

"While the report suggests that the committee is starting to think about raising interest rates at some point, it by no means suggests that a hike is imminent," said Jonathan Loynes of Capital Economics.

On Wednesday, news of a surprise increase in the number of people out of work and claiming unemployment benefit increased speculation that rates will remain on hold for now.

The MPC cut interest rates by two percentage points to their current 37-year low of 4% last year in an attempt at staving off recession.

The last reduction came in November 2001.

The MPC has not raised rates since February 2000.

The panel's next monthly meeting is scheduled for 5 and 6 June.