Bank sounds rate warning

THE City scribblers have been caught napping again. Just a fortnight ago they were unanimously agreed that the Bank of England would hold interest rates at 3.5% for the time being and most of them were forecasting there would be no change until 2004.

Indeed, the Treasury's October compilation of predictions from Britain's independent forecasters projects an end of year rate of 3.5%, rising to above 4% in 2004.

All of that changed with the issue of the latest minutes from the Monetary Policy Committee. The words had barely been flashed on to the screens in dealing rooms than a cry of surprise went up. Shares tumbled, the pound and interest rate futures climbed and the price of government stocks dived.

Seldom has there been such a sharp reaction to the minutes of the Monetary Policy Committee. What the four out of nine votes in favour of raising interest rates showed was that much of the analysis was plain wrong. On this occasion it took the casting vote by the governor Mervyn King to keep rates as they are and allow a smoother transition to higher rates.

So how did the change in sentiment on the MPC come about? The big factor was stronger demand. Plainly the Bank was perplexed by the sudden upward adjustment in growth rates which took place ahead of its October meeting, showing that output in the second quarter climbed by 0.6% - not 0.3% as originally announced.

New evidence of an upturn came with improved sentiment in the CBI's industrial trends survey.

Even cautious City analysts have started to raise growth projections. The consensus for this year is now 2% against 1.8% in the previous month. Next year, it is seen at 2.5%, up from 2.4% a month earlier.

There are other concerns at the Bank, too. The MPC was generally agreed that 'house prices, housing market activity and mortgage borrowing suggested that consumption growth would not moderate as quickly as previously expected'.

There also are fears that the build-up of household debt is risky and could lead to an 'abrupt' adjustment.

Even though inflation poses no immediate threat, all of this points to higher interest rates - and soon. The immediate questions are the timing and how much? Since the October meeting, we know that Mervyn King, who voted against an immediate rise, has toughened up his views.

In his Leicester speech last week, he talked of the 'nice' decade ending.

On timing, the Bank may not want to move ahead of receiving a full report on the nation's public finances from the Treasury representative Gus O'Donnell before the Pre Budget Report. That could hold matters up.

As for where interest rates are going, the market is already making its guesses. Gerrard says 4.75% by the middle of 2004, a substantial rise. Others see a more modest lift of three-quarters of a point.

But there must also be recognition at the Bank that raising interest rates too quickly could cause a housing shock and damage an export-led recovery by strengthening the pound.

Tax pointers

ONE piece of paper which Gordon Brown will be happy to refer to as he limbers up for a Pre Budget Report - showing a sharp rise in government borrowing - is the latest tax survey from the OECD.

This shows that despite all the accusations of secret tax rises, Britain is still doing better than most of its European competitors.

The tax take in Britain - at 35.9% of total wealth - is better than 10 other European Union countries, including France, which taxes at 44.5% of GDP and Sweden, which is above the 50% mark. Germany, often portrayed as a high-tax economy, is not far behind the UK, raising 36.2% in taxation.

The lesson the Treasury would like us to draw from these figures is that, despite all the criticism, Britain remains a low-tax economy. But caution is called for. The data is for 2002, before the surcharge on National Insurance contributions and the freeze on personal tax allowances came into effect.

Most worryingly, it may lead government to reach the wrong conclusion that it has headroom to raise taxes further without causing the pips to squeak. Ouch!

Hard times

IT is amazing what a good City row can do. Charles Allen, of Granada, may have been the winner in the battle for ITV plc, but the designated chief executive is having to recognise that he now lives in a new good governance era.

His two-year contract is destined for the dustbin and don't be surprised if he faces an effective pay cut in the shape of tougher performance conditions. None of this is before time.