Bank signals that rates could rise again

The Bank of England signalled yesterday that it might have further interest rate rises in store for homeowners as it battles to keep inflation in check.

Just a week after surprising markets with an increase in borrowing costs to 4.75%, the Bank said it still expected inflation to keep rising against a backdrop of record oil prices and higher university tuition fees.

Presenting the BoE's latest growth and inflation forecasts, governor Mervyn King was as reluctant as ever to discuss the likely path for rates but he stressed prices were set for a bumpy ride.

He said: "There remains great uncertainty about future energy prices, especially in the light of political tensions in the Middle East, and inflation is likely to be volatile over the coming months."

But he added: "We have not made a decision that it's necessary to raise interest rates further. I think we will have to wait and see for what other changes may or may not be necessary."

Last week's rise was the first in two years and was predicted by only a handful of City economists. Mr King rebuffed criticism that his Monetary Policy Committee had shocked markets and those who expected rate moves to be telegraphed were "barking up the wrong tree". He said: "The idea that it was a bolt out of the blue does not seem to me to fit with the facts."

The move followed a pick-up in inflation to a nine-month high of 2.5% in June, well above the Bank's government-set target of 2%. If inflation goes above 3%, Mr King will have to write an explanatory letter to Gordon Brown. "It's odds on we will have to write a letter over the next two years," he said.

Many City analysts who had thought last week's rate rise would be a one-off yesterday said another rise now seemed more likely given the Bank's inflation fears and an upbeat growth outlook.

"The MPC is refusing to sound the all-clear on interest rates," said Philip Shaw, chief economist at Investec, who is now forecasting a November hike. "There is a warning that rates may have to rise, but it will depend on the domestic and world-wide economy over the next months."

Mr King painted a rosy outlook for growth, saying household spending had recovered from a lull in early 2006, business investment was improving and the world economy was in good health.

Even the latest jump in people going bankrupt did not pose a threat to Britain's economy, he said, given that most people with secured debt, like mortgages, were still keeping up their payments.

As for first-time buyers now faced with the prospect of higher mortgage payments after the rate increase, Mr King said their main obstacle was not dearer borrowing but high house prices, which were finally rising at a more sustainable pace.

Some economists predict the Bank will have to tone down its outlook as economic growth slows in the US, where policymakers this week paused in their two-year long series of interest rate rises.

Mr King noted the slowdown but said the prospects for the eurozone were far more crucial for UK exporters.

He conceded, however, that times remained tough for manufacturers and profit margins were being squeezed by high gas and oil prices.

Those soaring energy costs have made firms hold back on pay rises, allaying policymakers' fears that high household bills, dearer petrol and council tax rises would prompt inflation-busting wage deals.

Mr King admitted that one of the factors keeping pay growth down, an influx of migrant workers, was not necessarily set to last. "Many of the anecdotal pieces of evidence suggest they are not here forever," he said.