MPC member's warning fuels rate rise fears

Interest rate jitters resurfaced yesterday after more hawkish comments from a member of the Bank of England's Monetary Policy Committee and news that firms are poised to push up prices at the fastest rate in a decade.

Tim Besley, the London School of Economics professor who joined the MPC last September, warned that the dominant services sector posed a risk to inflation because it was operating close to full tilt.

"We might reasonably expect inflationary pressure at the current time to be coming more from the services sector in the economy, in part driven by limited spare capacity," Mr Besley said in a speech to the Cardiff Breakfast Club. "Moreover, shortages of skilled labour in these sectors may lead to upward pressure on wages for such workers. This may lead to generalised wage pressure that will ultimately affect all firms in the economy."

The services sector, which covers everything from banking to hairdressing, is the engine room of the economy, accounting for two-thirds of total output. Latest surveys show it finished last year at a blistering pace, roaring ahead at the fastest rate for nearly a decade. The comments from Mr Besley suggest that last week's shock rate rise was aimed at putting the brakes on the sector to try to dampen upward pressure on wages and inflation.

Meanwhile, strong demand for both goods and services at the end of last year is making firms more confident about lifting prices, adding to concerns about rising inflation. The British Chambers of Commerce quarterly survey of 4,500 companies showed a net 39 per cent of manufacturers and 36 per cent of services sector firms intend to push through price rises, the highest balances since the second quarter of 1997.

"Firms are becoming more confident about their ability to pass on higher costs in the form of price rises, which will keep the MPC alert," said Ross Walker, economist at Royal Bank of Scotland. "We expect another quarter-point rate rise to 5.5 per cent, probably in May, and think the Bank is right to err on the side of caution. It can always lower rates if there are signs the economy is struggling."

David Kern, economic adviser to the BCC, disagreed, claiming a further increase in borrowing costs would harm business. "The crucial test remains the trend in labour costs," he said. "Unless there is firm evidence that private sector wage pressures are accelerating, there is no justification for pushing rates even higher."

Mr Kern also criticised the MPC for springing a surprise last week. "Shock tactics are unwelcome and potentially harmful," he said. "British business requires a stable and predictable interest rate environment."

Adding to rate nerves were figures from the Council of Mortgage Lenders showing banks and building societies dished out a record £346bn in new home loans last year, up a massive 20 per cent on 2005.