March 20, 2007 / 9:38 AM / in 10 years

Inflation rise fans rate hike talk

<p>Members of the public walk past a bank in Leicester, January 16, 2007. The inflation rate unexpectedly rose further above its target in February, boosting expectations the Bank of England will raise interest rates again this year.Darren Staples</p>

LONDON (Reuters) - The inflation rate unexpectedly rose further above its target in February, boosting expectations the Bank of England will raise interest rates again this year.

Sterling immediately rose three-quarters of a cent and interest rate futures and stocks fell on fears that higher borrowing costs will be needed in the months ahead to tame price pressures in the economy.

The Office for National Statistics said on Tuesday consumer prices rose by 0.4 percent last month, taking the annual inflation rate to 2.8 percent. Analysts had forecast a steady reading of 2.7 percent, already some way above the BoE's 2.0 percent target.

Air fares were to blame for February's acceleration even though fuel costs fell. A lot of this was due to the hike in air passenger duty announced in Chancellor Gordon Brown's pre-budget report in December.

"With Brown widely expected to announce a number of measures to increase tax on polluters in tomorrow's budget, the data comes as a timely warning that voter-friendly environmental policy could contribute to voter-negative monetary policy," said Gavin Redknap, an economist at Standard Chartered.

"Expect the next, and final, hike from the Bank to come by May."

The BoE has already raised interest rates three times since August to rein in inflation and send a tough signal to pay bargainers that it would not tolerate inflationary pay rises.

The RPI inflation measure, on which most wage deals are based, rose to 4.6 percent, the highest since August 1991. So far, however, there has been little evidence wages are soaring.

House Price Pressure

But the housing market continues to show a dogged resilience despite rising borrowing costs, with lenders notching a record month in February for loans and mortgage approvals.

Approvals are seen as a gauge of the future health of the market and, therefore, the data signal further strength -- a concern for policymakers who want to see house prices cool.

The Council of Mortgage lenders said gross mortgage lending notched almost 24.6 billion pounds and the Building Societies Association said approvals -- loans approved but not yet made -- amounted to 5.4 billion pounds last month.

The British Bankers' Association's measure of mortgage lending growth eased slightly, but held close to recent strong levels.

"Housing market activity still appears to be at relatively elevated levels and it seems that the cumulative 75 basis points increase in interest rates enacted so far since last August is yet to have a major dampening impact on activity," said Howard Archer, an economist at Global Insight.

With markets now betting on the risk of an imminent rate hike, investors will eagerly await the minutes on Wednesday from this month's BoE interest rate meeting for an insight into the appetite for further monetary tightening among policymakers.

Analysts expect the meeting to have resulted in a 7-2 vote in favour of holding rates steady, with Timothy Besley and Andrew Sentance seen voting for a hike again.

The hawks on the policy committee will be emboldened by separate data on Tuesday showing broad money supply growing at 12.8 percent on the year in February.

Policymakers have been concerned that too much cash in the financial system will spur inflationary pressures.

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