Four MPC members voted for rate rise

Expectation of an imminent rise in interest rates increased dramatically today as Bank of England minutes revealed that four of the nine members on the Bank's monetary policy committee (MPC) voted to raise the cost of borrowing earlier this month.

The closest vote for some time has shortened the odds for an increase in interest rates, currently at a 48-year low of 3.5%, before the end of the year - possibly as soon as next month.

"Minutes of the MPC meeting held on 8 and 9 October 2003, show a surprisingly narrow victory for the 'no change' opinion," said Andrij Halushka, economist for the Centre of Economics and Business Research. "The first interest rate rise in three years now looks a much closer prospect than it did before the publication of the MPC minutes."

In the Bank decision on October 9, Andrew Large, Kate Barker, Stephen Nickell and Paul Tucker voted in favour of a 0.25% rise in base rates, while the new governor, Mervyn King, sided with the bare majority. The news will come as a major surprise for the City as economists polled by Reuters had expected on average only two MPC members - probably the deputy governor, Ms Lomax, and Mr Tucker - to vote in favour of a rate rise.

A rise in interest rates before the end of the year will cause consternation for industrialists and unionists, who have pleaded for the Bank to hold off until the fledgling manufacturing recovery takes hold. Only yesterday, the CBI warned that an early rise in interest rates would be premature.

"Our worry is that the first rise [in interest rates] is the one that has the biggest potential for doing psychological damage to consumers and industry, so we would not want it to be premature," said Ian McCafferty, the CBI's chief economist.

The MPC last raised rates in February 2000 and this month's votes were the first for a tighter monetary policy since July 2002. A move to raise rates either next month or in December would end the longest period without an increase in borrowing costs since the 1940s.

In today's minutes, those favouring a rise in rates argued that "inflation was now clearly likely to be above target in two years' time, primarily because of higher domestic demand, and that an increase in the repo [base] rate was appropriate this month." Other arguments in favour of an increase included a more favourable global economic outlook, with the US recovery broadly on track and Japan showing some strength.

The majority of the members, however, felt that a premature rise in interest rates might choke off the improvement in business conditions, echoing the arguments by the CBI and the unions. These members wanted to hold off until a fuller analysis of economic condition was available in the November inflation report.

All MPC members, however, agreed that house prices, housing market activity and mortgage borrowing all suggested that consumer demand would not fall off as quickly as had been expected.

"Overall, the prospects for UK domestic demand appeared stronger, both on the months and relative to the August inflation report," the minutes said.

The MPC cut interest rates in July as a precautionary measure, but it may have acted on faulty information. The Bank's decision followed preliminary data from the Office for National Statistics (ONS) showing that the UK economy grew 0.3% in the second quarter. Since then, however, the ONS, with some considerable embarrassment, sharply revised those figures to 0.6%. Those members favouring a rise in interest rates, argued that revision of the growth numbers pointed to higher inflation.

MPC members were fully aware of the psychological impact of any decision to raise rates.

"Although financial market participants now generally expect the next move in rates to be upwards, they would probably be surprised if the increase were agreed at this meeting; for that reason as well, there might a sharper-than-normal market reaction," the minutes said.

But with the publication of these minutes, the markets will have been forewarned if the Bank does raise rates next month.