The Bank of England put the City on alert for further increases in borrowing costs yesterday as it issued its starkest warning yet to households about the dangers of taking on too much debt.
Publishing an upbeat assessment for the economy, Threadneedle Street said inflationary pressures were increasing faster than expected three months ago - a clear hint that last week's quarter-point rate rise may not be the last.
Mervyn King, the Bank's governor, said there was a danger that some households could find themselves in difficulties if borrowing costs increased or their economic circumstances changed, especially as the risks of a housing crash had grown.
"Everyone needs to think carefully about the amount of debt they can afford," he said.
But the Bank had not set out to scare consumers into tightening their belts with last week's rate rise, he added. Rather it had been forced to increase borrowing costs for the first time in nearly four years because house prices and consumer spending had not slowed as expected, increasing the chances that inflation would exceed the government's 2.5% target.
In its quarterly inflation report, the Bank warned that the longer house price inflation outpaced income growth, the greater the danger of a sharp correction.
Opposition MPs said the government had to step in to prevent a repeat of the early 1990s housing market crash.
"The government must act to encourage a soft landing for the housing market if we are to avoid the dreadful circumstances of the last crash, with negative equity and repossessions," said Vincent Cable, the Treasury spokesman for the Liberal Democrats.
But Mr King said if house prices did fall, the consequences for the economy were unlikely to be as severe as 10 years ago because fewer households had mortgages nearly equal to the value of their house. "There is no indication that the scale of the debt problem has risen over the last few years," Mr King said.
Britain had fared better than the other large economies since the start of the global slowdown in 2000, Mr King said - which explained why the Bank was the first of the major central banks to start raising rates.
"There is no doubt the hike last week is the start of an interest rate rising cycle," said Geoffrey Dicks, RBS Financial Markets chief UK economist. "Whether they will do anything in December or wait until the next inflation report in February is a 50:50 question."
But while traders are betting on interest rates reaching more than 5% by the end of next year, few analysts believe that rates will have to rise to that level.
