The Bank of England, fearing that Britain's housing market could be overheating, yesterday increased its key short-term interest rate by a quarter point to 5.25 per cent.
The rise, the first since June last year, stunned financial markets and sent the pound sharply higher against the dollar and euro but caused a sharp fall on the stock market.
The bank's rate-setting monetary policy committee (MPC) said it was worried about the property market, strong consumption and a tight labour market and said a pre-emptive rate rise now should mean rates would not have to go too high in future.
Its move completely wrong-footed City economists who were unanimous in a recent poll in predicting rates would be left at their 22-year low of 5 per cent, a level they were cut to just three months ago.
"I think [the bank's governor] Eddie George has decided he's not going to see a repeat of the 1980s housing boom," said Mr Glenn Davies, economist at Credit Lyonnais bank in London.
The MPC has faced growing signs in recent weeks that Britain's economic recovery is gathering pace and that the housing market is rocketing, particularly in London and the prosperous south-east.
Recent surveys have shown property prices rising 10 per cent a year across the country but by more than 20 per cent in some parts of London, levels which have created fears of a repeat of the 1980s housing boom, where price rises hit 34 per cent before crashing.
Sterling jumped 1.5 US cents against the dollar to a one-month high of $1.6261 and to 65.33p against the euro before dropping back slightly, while the FTSE 100 share index extended earlier falls to stand 87 points lower at 6,222.7 by mid-afternoon.
But it later recouped much of its mid-session weakness, closing a net 55.9 off at 6,253.6.
The nine-member MPC had slashed rates since last October by a total of 2.5 percentage points in an attempt to head off recession, and consumer and business confidence rebounded as a result. Now it is clearly worried that the economy may swing too far in the other direction.
Underlying inflation remains at 2.2 per cent, comfortably below the British government-set target of 2.5 per cent. But in its August quarterly inflation report, the MPC forecast that the index, which excludes volatile home loan costs, would be above target in two years, the MPC's preferred time horizon.
Most British banks followed the bank's move and raised their lending rates by a quarter point, except the Nationwide Building Society which trumpeted that it was keeping its rate on hold.
Banks had come in for heavy criticism for not matching the bank's last two rate cuts and their latest move is bound to raise more accusations of profiteering, even though mortgage rates are still close to 30-year lows.
Industry, which is just emerging from recession and has long pleaded for lower rates, condemned the MPC's decision.
"The monetary policy committee has yielded to the panic calls of the prophets of boom and this decision will shock and infuriate business," said Mr Ian Peters, deputy director-general at the British Chambers of Commerce.
