A shock rise in interest rates

The Bank's of England's decision to raise interest rates to 5.25 per cent was such as a surprise that one City economist put out his initial reaction under a pre-prepared headline about a no-change decision. “It shows I had been expecting no change!!” he said later with understandable honesty.

But he was not alone. All but one of 50 economists polled by Reuters the week before the 11 January decision had predicted the same outcome, and for similar reasons. Yes, inflation was high and rising and, yes, growth was strong, house prices were booming and retailers were doing fine, but the big unknown was whether any of that would feed through to wage inflation in the current pay round.

It turned out that the Bank was not prepared to wait. Perhaps it knows something that the City does not either from next week's inflation data for December or the results of some of their own research. Either way it shows that the Bank is very worried about the inflation and inflationary pressures and a majority of its monetary policy committee is not prepared to take chances of it getting out of control.

While it might be a happy New Year for the one City economist, Simon Ward of New Star Asset Management, it could prove a very miserable 2007 for those people struggling to meet their credit cvard payments, or more importantly, their mortgage bills. The Bank is sanguine that there are a small number of people suffering a large amount of pain. The number of the former will rise and it is possible, as the Building Societies Association warns, that this will turn out to be the straw that breaks the camel's back.

More interestingly it shows a willingness at the bank to surpise the markets. At the last Inflation Report press briefing, Governor Mervyn King was asked about academic research showing there was a danger of central banks becoming too transparent as they would only see their own views reflected back at them by the markets. He said that all any commentator needed to know was what was in the Inflation report. Whether a shock January rate rise was in the report is open to debate. Either way it shows that the Bank is happy to get a double the “bang for its buck” by shocking the markets.

So where do we go from here? To some extent we are unchartered waters at least as far as they last couple of years are to go by. One the one hand it could be a sign that the Bank wanted to send a firm signal to wage setters during the current wage round - only nine deals have been done according to Incomes Data Services. On the other it could show a hawkish mission to curb the highest inflation for a decade. Roger Bootle, the economic adviser to Deloitte who ironically won a reputation with hi seminal book Death of Inflation, believes rates culd hit 6 per cent.

I think they are done and that rates will peak at 5.25 per cent.