King Overruled as BOE Votes 5-4 for Unchanged Rate

Bank of England policy makers narrowly defeated Governor Mervyn King's bid to raise interest rates this month, adding to speculation of an increase as soon as July.

King, outvoted for the second time during his four years as governor, argued with three other policy makers that a quarter- point rate increase to 5.75 percent was needed because inflation risks are ``on the upside,'' minutes of the June 6-7 meeting showed today. Five of the Monetary Policy Committee's nine members overruled him, partly to avoid surprising financial markets.

The pound rose and investors raised bets on another rate increase after the publication of the vote, which wasn't predicted by any of the 26 economists in a Bloomberg News survey. King said last week that the bank ``may need to take further action,'' on inflation, which has exceeded the Bank of England's 2 percent target for the past 13 months.

``King calling for a hike is the writing on the wall,'' said David Brown, chief European economist at Bear Stearns International in London. ``The Bank of England is holding up the green flag for an increase in July. We see rates going to 6 percent this year.''

Rate Forecasts

Economists at JPMorgan Chase & Co., HSBC Holdings Plc, Lehman Brothers Holdings Inc. and Bank of America Corp. brought forward their forecasts for an increase in U.K. interest rates to July from August after today's minutes.

``There's certainly one more hike to come and the risks are on the upside after that,'' said Michael Taylor, an economist at Lombard Street Research in London.

Supporting King's view, money supply growth reached the fastest annual pace in seven months in May, manufacturers' optimism about their pricing power rose to a 12-year high and an index of price increases at shops reached the highest since 1998.

King was joined by John Gieve, Timothy Besley and Andrew Sentance in arguing for a rate increase because ``there was no compelling reason to wait,'' while the rest cited signs of slower consumer spending and house-price growth as reasons to keep rates unchanged.

Policy makers also disagreed on the impact of an increase on financial markets. King said that by moving now ``the peak in interest rates could eventually be lower.'' The majority countered that an increase this month ``would probably push the yield curve higher, which would not be warranted.''

Investor Speculation

Futures traders raised bets that the key rate will rise from the current 5.5 percent by September and cut forecasts on the level of borrowing costs next year. The implied rate on the September interest-rate futures contract rose 0.06 percentage point to 6.14 percent in London. The rate on the December 2008 contract fell 0.02 percentage point to 6.25 percent.

The contract settles to the three-month London interbank offered rate for the pound, which averaged about 15 basis points more than the central bank benchmark for the past decade.

The pound rose as high as $1.9934 after the report and traded at $1.9928 as of 12:22 p.m. in London. The currency reached $2.0133 on April 18, the highest in a quarter century.

King was last outvoted in August 2005, when the committee cut the rate by a quarter point to 4.5 percent. That move was reversed a year later. This month's decision was only the second where a governor has been overruled in the panel's 10-year history.

Britain's key rate is higher than the 5.25 percent in the U.S. and the European Central Bank's 4 percent rate. The Bank of Japan's minutes, published today, showed that policy makers in the world's second-largest economy plan to raise interest rates gradually. The bank has kept the key overnight lending rate on hold since doubling it to 0.5 percent in February.

House Prices, Debt

The Bank of England's four interest-rate increases since August may be starting to cool Britain's housing market, where prices increased more than 10 percent in the past year. House prices rose at the slowest pace in a year in May, the Royal Institution of Chartered Surveyors said June 14.

Britons have amassed a record 1.3 trillion pounds ($2.6 trillion) of debt. Consumer credit fell to the lowest in a decade in April and spending growth almost halved in the first quarter to 0.6 percent.

``Higher household debt levels might have increased the final impact of interest rate changes, which suggested raising interest rates at a measured pace,'' today's minutes reported the majority of policy makers as saying.

Inflation slowed to 2.5 percent in May, the weakest in seven months, because utility companies cut bills for electricity and gas. Annual gains in consumer prices have weakened from a decade- high of 3.1 percent in March.

Inflation Outlook

The U.K. central bank's May 16 forecasts show that inflation will slow to 1.8 percent in the middle of 2008, later than it predicted in February, before returning to the target in two years. The bank expects the economy to grow near 3 percent through 2008 and then slow gradually to just below that level in 2009. Growth was 2.8 percent last year.

``The Monetary Policy Committee will be watching closely indicators of capacity pressures, pricing intentions and inflation expectations,'' King said June 11. ``If these indicators remain elevated, the MPC may need to take further action.''

U.K. consumers' satisfaction with the Bank of England fell to a seven-year low in May, a survey commissioned by the central bank showed June 14. Inflation expectations stayed at an eight-year high in May, the survey showed.

source:www.bloomberg.com