How the Bank of England decides

The decision by the Bank of England to raise interest rates by a quarter of
a percentage rate will mean higher borrowing costs for people with floating
interest rates overdrafts and mortgages, or anyone planning to take out a
new loan. Banks and building societies tend to raise rates within days or
weeks of a decision by the Bank of England.

The rise will eventually be good news for savers with deposit accounts,
although it make take some time before the rates paid on their accounts
move upwards to reflect the increase. One of the ways banks and building
societies make money is to raise mortgage rates quickly but delay the rise
in savings rates, in order to maximise the margin they make for themselves.

The Bank's monetary policy committee (MPC) - a group of nine experts drawn
from the Bank of England and the outside world of academia and business -
decided to raise its base lending rate by a quarter of a percentage point
to 5.75 per cent.

There have been forecasts of strong house price growth for this year, and
the quarter per cent rise is unlikely to have an immediate effect on demand
for homes. Successive interest rate rises later in the year could, however,
in theory, apply a gentle brake to house price inflation.

In a terse statement issued alongside the decision at noon, the MPC
suggested that the shortage of workers in the UK's labour market and the
inability of the economy to meet current demand were likely inflationary
culprits.

The decision will, however, mean more pain for exporters, as an interest
rate rise tends to push up the value of sterling and make it more expensive
for overseas companies to buy British goods. It will also increase
borrowing costs for business which are taking out loans in order to expand.

The committee's decision sets the Bank of England's official lending rate
at the highest level for official interest rates since the start of January
last year, when rates were 6 per cent. Today's decision was the third time
the Bank has raised rates in the last five months. Analysts said the move
was a 'proactive' one by the Bank, designed to head off an outbreak of
inflation as the economy continues to expand strongly.

The decision reflects the need to keep inflation under control to avoid the
'boom and bust' economics which consumers and industry find so painful.
The MPC is charged by the government to keep official retail price
inflation - excluding the effects of mortgage payments - to 2.5 per cent
within a two year horizon. The latest inflation figures showed prices
rising at an annual rate of 2.2 per cent in November.

The move to raise rates was instantly criticised by a number of unions and
business groups, including the Confederation of British Industry, the
employers lobby group, that described the decision as 'unsurprising but
still disappointing'.

Engineering Employers' Federation director-general Martin Temple also
criticised the rate hike over the way the MPC had responded to recent
economic data. "[The MPC] is too quick to react to short term data,
inducing industry to manage in the short term," he said.

Union leaders attacked the interest rate rise, warning that firms will
find it more difficult to expand and export. Roger Lyons, general secretary
of the Manufacturing Science and Finance union, said: "This is a disaster
for manufacturing, particularly for jobs in the North."