Bank chief: 'Rates must go up next week'

By DAILY MAIL REPORTER
Updated: 05:18 EST, 27 June 2007

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Interest rates need to rise next week to help head off an unsustainable boom in the City and the property market, one of Britain's most senior bankers warned last night.

Sir John Gieve, deputy governor of the Bank of England, cautioned that 'spectacular growth' in borrowing for buyout and private equity deals could endanger the banking system and cause a sharp financial downturn.

He said the crisis must be controlled by higher interest rates.

The Bank is now widely expected to move to raise its key interest rate to 5.75% from 5.5% next Thursday, having narrowly voted against a rise in June. This would be the fifth rise in a year and put huge pressure on household budgets.

In a remarkable speech Mr Gieve, the former top civil servant in the Home Office, outlined the distortions to Britain's economy and property market stemming from London's emergence as the private equity and hedge fund capital of the world.

He noted that commercial property prices in the City were now twice those in New York and Paris. They are also double those in nearby Mayfair, which is home to most of the hedge fund companies.

'House price inflation in London has outstripped the rest of the UK,' said Mr Gieve, 'with prices in the smartest areas of Kensington and Chelsea climbing by 40% since the start of 2005.'

Residential rents in London now far outstrip those in New York and Paris. Moreover, the boom in the City - as the private equity bandwagon has rolled - meant that last year alone 4,200 workers in the Square Mile were paid bonuses worth more than £1m.

Only this week the private equity bosses of Saga and AA, which are merging, extracted £2bn of cash from the companies for themselves and their investors.

Meanwhile, two senior managers at the London-based hedge fund GLG stand to collect £1bn between them by floating their company on the New York Stock Exchange.

Turning to the exploding levels of pay in the boardroom, Mr Gieve notes that 'the average chief executive officer in the UK now earns 100 times that of the average worker'.

The result of this financial largesse is that Britain will almost certainly become ever more vulnerable to a global financial meltdown. 'As London strengthens its position in financial markets, the cycle in international finance will have direct effects not just through shifts in interest rates and asset prices but through jobs and pay,' Mr Gieve warns.

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His comments have an extraordinarily different tone from those of Gordon Brown who likes to claim that his policies as Chancellor eliminated the boom and bust of the economic cycle.

Mr Gieve points to the experience of the sub-prime lending crisis in the US - which is in danger of leading America into recession - and the collapse of the dotcom boom as examples of what can happen when the cycle suddenly changes direction.

The deputy governor suggests that the sharp rise in credit and the money supply, rising 13% year on year, could be signalling a serious problem. He notes the parallel of the late 1990s in Britain which was followed by a devastating downturn in residential prices and brought much of the high street to its knees.

Fears over the current credit boom, fuelled by private equity and the willingness of the banks to lend without proper guarantees, have led Mr Gieve to vote for four interest rate rises this year.

With house prices still rising and 'no sign of a slowdown in corporate lending', Mr Gieve leaves little doubt that he favours another rise in rates.

Explaining why he voted for a rise in June, Mr Gieve says that he felt 'the credibility of the regime was of greater concern, given the robust rate of growth, than an unnecessary slowdown in activity'.