BoE stuns markets with rate hike

LONDON Thu Jan 11, 2007 12:57pm EST

A Bank of England sign is seen outside the Bank of England in London November 9, 2006. British interest rates hit their highest level in nearly six years on Thursday after the Bank of England stunned markets by raising interest rates to 5.25 percent, the third quarter-point hike since August. REUTERS/Stephen Hird

A Bank of England sign is seen outside the Bank of England in London November 9, 2006. British interest rates hit their highest level in nearly six years on Thursday after the Bank of England stunned markets by raising interest rates to 5.25 percent, the third quarter-point hike since August.

Credit: Reuters/Stephen Hird

LONDON (Reuters) - British interest rates hit their highest level in nearly six years on Thursday after the Bank of England stunned markets by raising interest rates to 5.25 percent, the third quarter-point hike since August.

Wrongfooted analysts immediately wondered whether policymakers knew something they didn't.

Perhaps figures due to be published next week, but already seen by the Bank, would show inflation exceeding three percent, forcing a letter of explanation to the government.

The central bank is clearly worried. It blamed an economy pushing the envelope for rising price pressures and said inflation would rise even further before easing back toward the 2.0 percent target.

Economists said further interest rate increases could lie ahead and futures markets quickly moved to reflect the possibility of two more hikes before the year was out.

The pound soared toward a six-year high and stock markets were rattled, sending Britain's FTSE 100 .FTSE into the red and weighing on the European FTSEurofirst 300 .FTEU3 index despite euro zone borrowing costs being left steady.

UK inflation hit 2.7 percent in November, its highest since comparable records began a decade ago. The Bank's mandate requires it to write a letter to the government if it strays from target by more than one percentage point.

"Markets are going to be wondering if this marks a more intensive process of monetary tightening," said Peter Dixon, economist at Commerzbank.

"Is the Bank going to raise again? That's the question that is going to be ringing round the dealing rooms this afternoon."

BELT AND BRACES?

The truth is no one can be sure. The BoE prides itself on being predictable but only one of the 50 analysts polled by Reuters had predicted the latest hike. August's move was equally surprising.

Many analysts had thought November's hike had just been insurance against wages rising too fast in the New Year and thought the central bank would at least want to wait for New Year settlements data before making up its mind.

"We're rethinking our interest rate forecasts. The MPC has surprised financial markets twice now within the space of six months and at this juncture it's impossible to rule out another surprise," said Philip Shaw, chief economist at Investec.

Concern about spare capacity aside, the BoE's statement did little to illuminate the Monetary Policy Committee's thinking.

Wages, the big bugbear in recent months, were not even mentioned nor was there any talk of the spike in inflation expectations seen last month that may have got policymakers worried about a 2 percent target.

House prices were also conspicuous by their absence given one of the main surprises at the December meeting had been the property market's resilience in the face of two rate hikes.

"The last two rate rises seem to have had little dampening effect on the housing market," said Adrian Coles, director general of the Building Societies Association. "There will inevitably be a few people for whom this rate rise is the straw which breaks the proverbial camel's back."

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