Bank blames wage rises for hike in interest rates

The Bank's independent monetary policy committee decided in its regular monthly meeting that the economy still shows signs of overheating. It has a statutory responsibility to keep average inflation - now at 4% - at 2.5%.

Bank economists said the move was motivated by fears that private sector pay rises are undermining efforts to keep inflation under control. Marks & Spencer's decision to award its 57,000 employees a 5.25% increase was identified as a deciding factor.

The move, which took immediate effect, will bring good news for savers, who were promised an increase in savings rates by banks and buildings societies. But big lenders said they would wait before putting up the cost of mortgages.

The business community warned it would push the economy towards recession at a time when companies are reporting falling investment and warning of falling profits.

The Prime Minister's official spokesman defended the decision to take interest rates out of the hands of politicians and hand them to the Bank. ''They have to have the power to take action to root out any potential sign of inflation. You cannot in any circumstances go back to the days of boom and bust. His opinion is that this is the way to deal with the boom and bust for good and that's what we intend to do.''

Headline inflation in April rose sharply to 4%, from 3.5%, while the underlying rate - which excludes mortgage payments - rose from 2.6% to 3%.

Economists warned the higher rate would put renewed pressure on manufacturers competing in the export market, who are already technically in recession. They also said it could reverse the fall of the pound and send it climbing back to the critical DM3 level.

The stock market tumbled on the news, though the FTSE-100 index later recovered to end the day 37.6 points down at 5860.9 points, while the pound initially climbed sharply, only to slip back and close almost a pfennig lower at 2.8930 points.

The Bank has been using incremental quarter point increases in an attempt to dampen inflationary pressures without sending the economy into recession. But the inflation rate has stubbornly refused to move towards the 2.5% average ordered by Chancellor Gordon Brown when he gave the Bank independent control of the borrowing rate last May.

Marian Bell, Treasury markets economist at the Royal Bank of Scotland, criticised the decision. ''The data is showing that the UK economy is slowing very nicely, which would suggest the rise wasn't necessary,'' she said.

A statement from the Bank committee made clear the effect of rising wages was to blame. ''Developments in the labour market are a key determinant of domestically generated inflation,'' it said.

''Evidence has emerged over the past month that the cumulative tightening of the labour market has resulted in a rate of private sector earnings growth that jeopardises achievement of the inflation target over the medium run.''

Some specialists were quick to blame Marks and Spencer's decision to give its shop staff an above-inflation increase. Jeremy Batstone, head of research at NatWest Stockbrokers, said: ''What appears to have happened is that the Bank of England has acted on the back of increases of employment and inflation wage rises and cited this as the rationale for the rate hike.

''The most negative piece of data in recent weeks was the inflationary wage award to employees at Marks & Spencer. It is possible that this was a contributory factor.''

Kate Barker, chief economic adviser at the Confederation of British Industry, said the CBI was ''very concerned'' by the rise and warned it had struck a fresh blow against exporters.

TUC general secretary John Monks said: ''This increase is as unnecessary as it is unexpected. It increases the risk of a hard landing and will hit investment and jobs.''

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