Rates 'could rise by year end'
Interest rates are expected to rise by the end of the year after Bank of England governor Mark Carney warned that the first hike from the historic low of 0.5% could come sooner than expected.
Economists said Mr Carney's surprise move had put households, businesses and markets on notice that an increase in the cost of borrowing was fast approaching.
The move will spell higher repayments on many mortgages linked to the Bank rate but relieve hard-pressed savers who have been squeezed by it being left at 0.5% for more than five years.
Mr Carney said: "There's already speculation about the exact timing of the first rate hike and the decision is becoming more balanced. It could happen sooner than markets currently expect."
His remarks sent the pound surging close to 1.70 US dollars, a level not seen since 2009, while it also reached a 19-month high against the euro. Analysts had previously been expecting the first hike in spring next year.
He pointed to growth being much stronger and unemployment falling much more quickly than had been expected.
Mr Carney caught the City off guard when he used his first Mansion House speech as governor to say that the "gradual and limited" increases that would be needed as the economic recovery progresses were "coming nearer".
Investec economist Victoria Clarke said: "Carney has come out and surprised markets and effectively put households, markets and businesses on notice that an interest rate hike is imminent. Certainly that looks likely by the end of the year now."
She pencilled in a first hike being signalled around the time of the Bank's quarterly inflation report in November.
"We have got the election in May next year so it's possible that that has swayed the decision to start looking at a rate hike sooner.
"It gives the Bank of England the opportunity to make an adjustment to rates and have a look at how that affects the economy for a few months."
Ms Clarke said the comments had come "to a certain extent from left field" but there had been warning signs including figures earlier this week showing that the unemployment rate had fallen to a five-year low.
Mr Carney's tone was in contrast with remarks last month when he appeared to dampen speculation about an early rise.
Rob Wood, chief UK economist at Berenberg, said they were an "abrupt about face" after indications from the Bank last year that rates were unlikely to rise until late 2016 at the earliest - but that they were sensible.
"The change reflects the reality in the economy. It is flying now. Employment is rising at a record pace and we see no sign of economic growth slowing."
There was speculation that minutes of the last meeting of the Bank of England's rate-setting committee, to be released next week, might show one or two members voting for a hike after a period of unanimously backing no change.
Interest rates were last increased in the summer of 2007. They were slashed to 0.5% at the height of the downturn in March 2009 as policy makers aimed to help nurse the economy back to health, and have remained there ever since.
Mr Carney also signalled that the Bank could take "graduate and proportionate actions" within weeks as a separate measure to cool the threat of an overheating housing market - described as the greatest danger to the economy.
The Bank's Financial Policy Committee (FPC) has powers to recommend caps on loan-to-income and loan-to-value ratios on mortgages.
Chancellor George Osborne has announced plans to strengthen these powers to enable the FPC to take the measures independently.
But the governor said that such "insurance policies" would not necessarily affect the path of interest rate increases.
Mr Carney said the need to use up wasteful spare capacity while achieving the inflation target of 2% would "likely require gradual and limited interest rate increases as the expansion progresses".
"The start of that journey is coming nearer," he added.
The prospect of a sooner-than-expected rate rise meant shares in housebuilders were sharply lower , with Persimmon and Barratt Developments down by more than 4%. The potential impact on consumer spending from higher borrowing costs also caused a fall in retail stocks.
The British Chambers of Commerce (BCC) urged the Bank not to "jump the gun" on interest rate rises.
Adam Marshall, the BCC's executive director of policy and external affairs, said: "Earlier than expected rate rises could mean that current levels of growth are "as good as it gets" for the UK economy.
"The case for acting more swiftly has not yet been made. If the housing market is the principal concern, there are other tools at the Bank of England's disposal to cool the market.
"If we are to see continued business investment growth, following the abysmal levels seen over far too many years, companies need to be confident that they will be working in a low interest rate environment, facing only gradual rather than sudden change."
BCC chief economist David Kern said Mr Carney's remarks added to upward pressure on the pound following the European Central Bank's recent rate cut which has sent the euro lower.
He added: "Global growth forecasts have been revised down recently, and the UK recovery is still facing obstacles. It is therefore premature to consider early interest rate increases."
CBI director-general John Cridland said: "With the economic recovery firming up nicely, any change in monetary policy should ensure this isn't blown off course.
"The Bank has clearly stated in its forward guidance that when rates do begin to rise they will do so gradually and to a level materially below their pre-crisis average.
"With markets up until now expecting a rise in the spring of next year, businesses will be alert to any further communications from the Bank."