A surprise three-way split in the Bank of England’s rate-setting Monetary Policy Committee this month, with one member backing an immediate rise in interest rates, fuelled uncertainty in the City yesterday over the Bank’s likely next move.

The news that Professor Tim Besley, the MPC’s most hardline member, broke ranks to demand a rate rise to bolster its credibility in its fight against inflation emerged in Bank minutes to startle markets and City economists. The tough stance by the external MPC member came as the CBI’s latest industry survey showed manufacturers grappling with the fiercest cost pressures since 1980.

It marked the first vote for a rate rise among the nine-member committee since June last year, and rekindled speculation over the scale of the threat of a future increase in borrowing costs.

However, most economists still believe that rates will stay pegged at 5 per cent, before an eventual cut, after seven other MPC members led by Mervyn King, the Bank’s Governor, voted for no change this month. One, Professor David Blanchflower meanwhile backed a cut for a tenth month in a row, as had been widely expected.

The unusual three-way split was the first such division among the powerful committee since May 2006.

Although any rise in base rates is still seen as unlikely for now, the sharp difference of opinion fuelled City nervousness over prospects for borrowing costs as the Bank battles with conflicting pressures from surging inflation as well as weakening economic growth.

The edginess was intensified as, with the exception of Professor Blanchflower’s views, there was little discussion of cutting rates, while the case for a rise was closely examined.

Professor Besley argued that rates should rise immediately to “ensure the committee’s credibility in the light of the current and prospective increase in consumer price inflation".

He said that dearer borrowing costs would help to make certain that workers and companies did not react to expectations of higher inflation in a way that would entrench in into the economy.

The MPC as a whole debated whether higher rates would send a strong signal of its determination to bring inflation down to its 2 per cent target. The decision was said to be a difficult one since inflation was likely to be higher and growth lower than in the Bank’s last quarterly forecasts, made in May.

However, the majority of the MPC agreed that a spate of bad economic news pointing to a sharper slowdown in the economy meant it was possible that higher rates would not be needed.

They also agreed that a rate rise this month could slow the economy so much that inflation would eventually drop back below the target level.

“Keeping Bank rate at 5 per cent when the economy was slowing was arguably already sending a strong signal of the MPC’s commitment to reducing inflation,” the majority felt.

The MPC’s dilemma was emphasised by yesterday’s CBI survey which showed manufacturers struggling with both potent inflationary pressures and wilting confidence and activity.

Inflation worries were reinforced as the proportion of manufacturers hit by rising costs reached the highest for almost three decades. Companies are responding by raising prices, with the CBI’s gauge of prices for goods leaving factories reaching the highest since April 1995 during the past quarter.

Sentiment in manufacturing is being battered, with confidence in the past quarter sinking to its lowest since 2001. The pessimism comes as expectations of future output fell to a five-year low this month. The CBI said it expects that 36,000 jobs could be shed in manufacturing over the second and third quarters.

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