The Bank of England has raised interest rates by 25 basis points to a six-year high of 5.5% as expected.
It’s the fourth increase in nine months, lifting its benchmark interest rate to its highest level since April 2001.
The bank said in a statement that output growth had remained firm and that business investment was stronger than expected.
'Although indicators of consumer spending have been volatile, the underlying picture is one of steady growth. Credit and broad money continue to grow rapidly. The pace of expansion of the international economy remains robust,' the bank said.
The rate hike is a bid to fight inflation which hit 3.1% in March, causing bank governor Mervyn King to write a letter to Chancellor of the Exchequer Gordon Brown to explain the situation.
Other indicators of the robust economy are 40 consecutive quarters of growth, the lowest unemployment in a year in March, the highest pound against the dollar in 25 years in April, a 10-month high in manufacturing production in March and a forecast that gross domestic product growth will hit 3% this year from 2.8% in 2006.
Interest rate hikes aim to cool the economy by making money more expensive to borrow. Home owners can readily see the difference if they have adjustable mortgages.
A quarter percentage point rise for home owners with a 25-year repayment plan on a £250,000 mortgage would see their monthly payment of £1,550.08 at 5.48% rise £38.07 to £1,588.15 at the new rate of 5.73%.
An interest only plan would rise £52.08 to £1,193.75 from £1,141.67.
House prices have increased by 10.9% in the three months to April, according to HBOS, the UK’s chief mortgage lender.
There was some concern that the UK bank committee would vote to increase interest rates by 50 basis points, but it was discounted by most economists. Some forecast an increase to 5.75% by year end even though inflationary pressures in some areas such as gas and electricity prices are expected to ease.
F&C Investments fund manager Ted Scott believes that the bank should have gone further in order to stamp out inflationary expectations.
'Many people will be expecting another 0.25% rise after today's rate hike but a bigger than expected 0.5% rise would have been more effective in slaying inflationary pressures than this incremental approach,' said Scott.
Scott, who manages the F&C UK Growth & Income, Stewardship Income and Stewardship Growth funds, said that house builders and general retail would be most affected by today's rate hike.
The buy-to-let segment of the property market could be increasingly fragile if investors are forced to sell, which could lead to a crash in the housing market, he said.
'If rates are hiked a second time later this year general retailers such as Marks & Spencers and Next could see sales dip and financial stocks such as banks and other lending institutions could also be affected," Scott added.
Simon Ward, chief economist at New Star Asset Management, said the combination of three earlier hikes plus a 5% rise in the exchange rate over the last year has already tightened the money supply.
‘The bank needs to be aware of overkill,’ Ward said. ‘There are signs that growth is beginning to slow, while inflation news is set to improve. A move beyond 5.5% would risk unnecessary economic weakness in 2008.’
The hike gives the UK the highest cost of borrowing money among Group of Seven countries. The European Central Bank was expected to leave its interest rate at 3.75% for the euro zone when it meets today in Dublin. The US is at 5.25%, Canada has 4.25% and Japan is at 0.5%.
Jon Maguire, chief executive of cru Investment Management said he wouldn’t be surprised if the bank’s quest to control inflation invoked a 6% interest rate this year.
2008 could get even worse and it wouldn’t surprise me if the housing market crashed,’ Maguire said. ‘The current situation is very similar to 1989 and terms such as negative equity may well revisit the UK with a vengeance.’
The bank is to give its guidance on inflation for the rest of the year next week.
