Interest rates look set to rise

INTEREST rates may have to rise again to head off the boom in household spending and borrowing, the Bank of England governor warned yesterday.

Mervyn King told MPs that the fast growth in the economy seen towards the end of last year had continued into the first quarter of 2004.

As a result, the Bank's monetary policy committee may be forced to act early to head off higher inflation by lifting its base loan rate.

Giving unusually outspoken evidence, Mr King expressed worries that the economic recovery has become 'unbalanced'.

Consumer borrowing is showing no signs of slowing, but manufacturing and exporters are suffering because of the strength of the pound.

'The effective exchange rate is about 6% higher than when (the monetary) committee last met and is continuing to make life difficult for many exporters,' he said.

His comments caused the pound to dip sharply against the dollar - to $1.81 - and the euro.

The Bank has raised its base rate twice, to 4%, since November to force up the cost of credit and mortgages. But Mr King admitted that this had failed to curb consumption.

'Consumer borrowing and spending have been rising faster than expected,' he told the Commons Treasury Select Committee.

Household consumption is estimated to have grown by 1% in each of the last three quarters, according to several surveys.

City economists believe a rate rise of a quarter point to 4.25% is likely when the monetary policy committee meets on April 7 and 8.

The Bank has been unusually forceful in recent days in pointing out its growing fears about the consumer boom.

Deputy governor Sir Andrew Large warned earlier this week that the build-up of household debt to levels not seen since the early 1990s might not be sustainable. Sir Andrew is among the Bank's leading interest rate hawks, voting for an increase at several recent monthly committee meetings. Mr King had been hoping that consumer demand and the housing market would slow this year to create room for manufacturing recovery, without causing overheating and higher inflation.

But the prospects for 'rebalancing' the economy have not been helped by the rise in the pound, which was making life difficult for exporters.

He suggested it would be possible to bring the economy back on an even keel without causing a crash in the housing market or difficulties for borrowers.

'There is no reason to suppose that the increase in debt will lead to a large jolt in consumer spending,' he said. Figures from the British Bankers' Association suggest that, while mortgage lending was relatively slow in February, a big pick-up is expected in the spring. Data also shows consumer borrowing to be still rising.

The Bank is plainly worried that the improvement in business investment and manufacturing reported yesterday by the Confederation of British Industry could be hurt by the strong pound.

There is also belief at the Bank that there is not enough capacity in the economy to sustain both a consumer boom and a manufacturing recovery.

In his Budget last week, Gordon Brown did nothing to slow the economy and the burden of adjustment is now with the Bank.

At least three members of its interest rate committee have said since the Budget that rates would have to rise.

Mr King said this can happen without triggering problems. But he noted that there was 'plenty of scope for surprises in either direction on the inflation front'.