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Bank of England raises UK interest rates to 5.25%, catching the financial markets off guard

Interest-Rates / Strategic News Jan 11, 2007 - 08:13 PM GMT

By: Nadeem_Walayat

Interest-Rates

The Bank of England raised interest rates by 0.25% to 5.25%, whilst most of the city of London was caught of guard and had already started to consider the next move for a cut in interest rates. If you have been following our forecasts and analysis at the market oracle you will be aware that we are expecting interest rates to rise to 5.50% this year and possibly even as high as 5.75%. Whilst the first anticipated rise in interest rates was Feb. 07, this rise is one month early. Though only one of 50 economists polled by Reuters predicted an increase in interest rates.


The British Pound (GBP) immediately surged higher on the news to above 1.9500, afterwards settling at 1.9430. This rise and future anticipated rises are now expected to support sterling, even though the weak technical picture as per our forecast of 4th of Jan 07 remains. Infact a point missed by virtually all of the media is that the BoE took the recent weakness in sterling as a cue to raise interest rates earlier than expected. As sterling would have acted more strongly if the rise had occurred during a period of sterling trend strength. This now leaves the door open for another rise in UK interest rates early in the 2007 without igniting a stronger sterling rally than what would otherwise have transpired.

In a statement the Bank said: "The margin of spare capacity in the economy appears limited, adding to domestic pricing pressures. CPI inflation was at 2.7 per cent in November. It is likely that inflation will rise further above the 2% target in the near term, but then fall back as energy and import price inflation abate."

The rise in UK interest rates now match those in the USA at 5.25%, both well above the European Interest rates at 3.5% which are expected to continue to rise to above 4% this year.

Another possible reason why the BoE chose to act now in January, rather than February is that a lot of private sector pay deals are made in January thus the Bank was looking to squeeze company cash-flows and profit forecasts, so as the companies would be less eager to raise pay deals substantially. The rise also signals to the market that more are likely during the year as the Bank of England seeks to do battle with inflation.


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