Housing boom forces third rise in rates

Britain's 11 million mortgage payers were last night facing their third increase in home loans within six months after the Bank of England admitted that it had been taken by surprise by the strength of Britain's housing boom.

Despite inflation being well below the government's target, the Bank moved to rein in the rapid growth in borrowing when it pushed up interest rates by 0.25 points to 4.25%.

Industry and the City had been braced for the move and the country's second and third biggest home loan providers - the Abbey National and the Cheltenham & Gloucester - responded by increasing their variable rates to 6.25%.

The rise will add almost £17 a month to an £80,000 interest- only mortgage and almost £21 a month to someone with a £100,000 home loan.

Analysts said yesterday's increase was unlikely to be the last; the City is pencilling in a further rise to 4.5% in August.

The National Consumer Council urged borrowers to "think long and hard" about taking on further debt, but the National Association of Estate Agents said the small increase in rates was unlikely to damage the housing market, where prices are rising at almost 20% a year.

In a statement explaining the decision, the monetary policy committee (MPC) said "output growth has been at or above trend and business surveys are consistent with further strengthening. Retail spending continues to be robust, underpinned by income growth and unexpectedly strong house price inflation. Investment prospects have improved."

Inflation stands at 1.1% and the Bank said it was expected to remain below the chancellor Gordon Brown's 2% target in the near term. But it warned that higher earnings and the rise in commodity prices which has seen the cost of oil jump to $40 a barrel in world markets posed a growing inflationary threat to an already robust economy.

"With a small and diminishing margin of spare capacity, inflationary pressures are likely to build despite a higher level of sterling than at the beginning of the year."

Against that background, it was necessary to raise interest rates in order to keep inflation on track to meet its target over the medium term.

Industry's reaction to the news was mixed. Trade unions criticised the decision, claiming it was unjustified and would damage the still fledgling recovery in manufacturing. Derek Simpson, general secretary of Amicus, said jobs in industry were still being lost at between 10,000-12,000 per month.

Ian Brinkley, chief economist at the TUC, said: "Manufacturing, whilst improving, is still on very shaky ground, and today's decision will do nothing to improve the sector's chances."

The Confederation of British Industry (CBI) praised the Bank's recent "well-signalled, gradual approach" towards raising rates but warned that firms would be more concerned if it heralded the start of a rapid approach to raising borrowing costs.

The CBI's chief economic adviser, Ian McCafferty, said: "The two previous increases have not yet had time to take full effect and business is still concerned that sterling's renewed strength could hold back the recovery."

Yesterday's move came in the wake of figures showing net mortgage lending rose by £9.34bn in March.

Oliver Letwin, the shadow chancellor, said: "I hope that the action by the Bank of England will begin to calm the housing market. I just hope that action by the Bank will be sufficient to counteract the effects of the chancellor's policies, which are diminishing the appetite to save and encouraging risky levels of household borrowing."