Bank lines up shock rate rise

ODDS are shortening on a 'nuclear strike' by the Bank of England this week in the form of a shock half-point rise in the base rate.

A quarter-point rise - to 3.75% - is being taken for granted when the Bank's Monetary Policy Committee announces its decision on Thursday.

But money markets are starting to bet that the MPC could take more drastic action to cool off the creditfuelled consumer boom and jack up borrowing costs to four%.

'The market rate for the end of December is 3.86%,' said Peter Dixon, economist at Commerzbank. 'Given that no one expects the MPC to move in December, immediately ahead of Christmas, this means dealers think there is a 50-50 chance the MPC will go for the full half point.'

If it does, this would be the first time since the MPC was established in 1997 that it has moved rates up or down by more than a quarter of a percentage point in any one meeting.

Tomorrow the latest business trends survey from accountancy group BDO Stoy Hayward will show the biggest jump in inflation expectations among business people in the survey's history, adding further to the pressure for a sharp rise in the base rate.

Until October 22, when the minutes of last month's MPC meeting were published, City analysts had ignored persistent warning signals from the money markets of an imminent rise in borrowing costs. Most economists believed rates would stay on hold until at least February next year.

Then the minutes showed that only one vote had stopped a quarter-point rise in October. Buoyant economic figures-since then make a rise this month almost inevitable.

'The markets got that right and we did not,' admitted Trevor Williams, economist at Lloyds TSB. 'And there is a chance the money market is right this time too, and that the MPC will go for a full half point. But I still believe the chance is a slim one.'

Even if rates rise only to 3.75%, 'this could tip the consumer the other way' into severe cutbacks in spending, according to Dhaval Joshi of SG Securities. In the immediate future, he said, this would mean a miserable Christmas for retailers. In the longer term, it could combine with employment insecurity as servicesector jobs migrate abroad to depress consumer spending severely.

'The stock of debt is very large,' he added. 'This makes consumers sensitive to even modest rate rises.'

John Butler, economist at HSBC, said: 'The bottom line is that the rise in debt implies that British consumers are more sensitive to adverse shocks, including interest-rate changes, than in the past.'

Dixon agreed: 'It is wrong to say that debt servicing costs for households must be low simply because interest rates are at a 50-year low.

'People have racked up so much debt that just three quarters of a point on base rate, to 4.25%, would take the servicing cost to ten% of income, which is the long-run average since 1987.'

He added that any rise would be 'an unwelcome Christmas present for retailers'.

Richard Jeffrey, economist at Bridgewell Securities, forecast that sales of alcohol, tobacco, restaurant meals and hotel accommodation would be hit hardest by higher rates.