The Bank of England's Monetary Policy Committee voted by the narrowest of margins, 5-4, to raise interest rates to 5.25 per cent this month, minutes of the meeting published today showed.
The pound fell sharply against the dollar after the minutes, while gilts, interest rate futures and British equities extended their gains as the close call suggested borrowing costs are at or close to their peak.
Analysts had expected a 7-2 vote. Minutes of the January 10-11th meeting published today showed Chief Economist Charles Bean, Deputy Governor Rachel Lomax, Paul Tucker and David Blanchflower voted to keep rates steady, arguing policymakers could afford to wait until February's inflation report.
"For a majority of members there was already sufficient evidence to justify an increase in Bank Rate and no compelling reason to delay," the minutes said.
"An early increase in rates might prevent larger increases later," they said, echoing comments made by BoE Governor Mervyn King in a speech on Tuesday which markets had interpreted as dovish.
The minutes showed the MPC thought the world economy was robust, domestic demand was growing strongly and British output was growing at least at its potential rate.
Data today reinforced the view that Britain's economy was in rude health, showing it grew at its fastest rate since 2004 in the fourth quarter of 2006.
The hawks on the MPC were also concerned at the shrinking of spare capacity and said inflation had been rising because it had become easier for firms to increase prices.
"There was a significant risk that inflation would not fall back as quickly as the Committee had expected in its central case in the November inflation report and little risk that an increase in interest rates would cause an unnecessarily sharp slowdown in activity," the minutes said. Inflation spiked to 3 per cent in December, at, but not above, the upper limit set by the government.
While the MPC agreed the risks to inflation had shifted upwards, the doves were concerned a January move could be interpreted as a knee-jerk reaction rather than waiting for more information given the volatility of energy and food prices.
Both sides agreed that it was important that the rise in inflation should not feed through into pay deals but noted there had been little sign of that happening yet.