Bank of England raises interest rates

/ Source: The Associated Press

Worries about creeping inflation spurred the Bank of England to make a surprise increase in its main interest rate Thursday, while the European Central Bank held steady but hinted at an increase of its own to come.

The Bank of England lifted the key rate from 5 percent to 5.25 percent to its highest point since May 2001, despite expectations for no move. Policy-makers in Britain are concerned about rising inflation rates, which reached 2.7 percent in November — above the bank’s target of 2 percent for the seventh month in a row.

British interest rates are now level with those in United States. The increase makes mortgage and loan repayments more expensive, and was criticized by some consumer groups, retailers and employers’ groups.

The ECB, meanwhile, left its benchmark rate unchanged at 3.5 percent, but President Jean-Claude Trichet’s comment that it would engage in “very close monitoring” of inflation risks was taken by most analysts as a signal that a quarter-point hike could be in the cards for March.

Annual inflation in the euro zone was at 1.9 percent in December, just below the ECB’s target of about or below than 2 percent.

“Frankfurt clearly is a less hectic place than London,” said Holger Schmieding, Bank of America’s chief economist for Europe. “Whereas the Bank of England shocked observers like us with a surprise rate increase today, the ECB calmly confirmed expectations that it will raise its rates again by (a quarter of a percentage point) in March.”

By waiting, the bank — which sets policy for 13 nations with more than 316 million people and a combined gross domestic product that accounts for more than 15 percent of the world’s economy — allowed itself to get a better picture of the effect of a value-added tax increase in Germany and see more fourth-quarter gross domestic product data.

The German government announced earlier Thursday that the nation’s economy — Europe’s largest — expanded by 2.5 percent in 2006, its fastest rate since 2000. The Eurostat statistical agency, meanwhile, said economic growth in the euro zone slowed in the third quarter of 2006, but full-year figures were not yet available.

The ECB’s forecasts for euro-zone growth this year are between 1.7 percent and 2.7 percent, up from 1.6 percent and 2.6 percent issued last year. For next year, GDP growth is expected to be between 1.8 percent and 2.8 percent.

“In an apparent effort to drive home the point that the ECB does not intend to raise rates in February, Trichet pointedly noted in the press conference that the ’mood’ of the ECB Governing Council had ’not changed much’ since December, with the economy developing in line with the ECB’s baseline scenario,” Schmieding said.

While Trichet said euro-zone inflation is expected to hover at around 2 percent this year and in 2008, analysts expect inflation to rise above the ECB’s target early this year and lead to a rate increase in March.

In Britain, inflation has been running above the bank’s 2 percent target for seven successive months and is now at 2.7 percent, with economists predicting a rise to 3 percent when the December figure is published next week.

“It is likely that inflation will rise further above the target in the near term,” the Bank of England noted in a statement saying the rate increase was needed to control inflation.

The Bank of England sent the pound up to $1.9483 against the dollar, compared with $1.9324 late Wednesday. The euro fell to $1.2948, an eight-week low against the dollar. Higher interest rates support a currency by making some assets denominated in that currency more attractive to investors.

Many analysts saw the Bank of England’s move as an early step to control the effects of wage agreements that could spur higher inflation.

“The surprise value of a move today may be seen as an opportunity to derive more bang per buck from the move,” JP Morgan Chase economist Malcolm Barr said.

For Britons, the bank’s decision will mean higher rates on their mortgages, auto loans and even credit cards and comes just weeks after a holiday season that saw record retail sales, leading to fears of defaults on loans and more.

“We are already seeing a rapidly growing number of people falling behind with mortgage payments and in some cases threatened with repossession, and we know some people are taking on mortgages that stretch them to the absolute limit,” said Peter Tutton of the consumer activist group Citizens Advice. “Any increase in mortgage interest rates could spell disaster for people whose finances are balanced on the very edge of affordability.”

Graeme Leach, chief economist at the Institute of Directors, called the decision “tough but wise.”

“Inflation is well above target, spare capacity is low, money supply growth is high and the housing market looks perky,” he said. “Throw in on top the risk of accelerating wage settlements and the Bank of England’s pre-emptive strike looks sensible.”