Bank no closer to hike as economy concerns persist

Two men shake hands on the steps of the Royal Exchange next to the Bank of England (L) in the City of London March 10, 2011.

LONDON (Reuters) - The Bank of England came no closer to raising interest rates this month as concerns about the strength of the economy outweighed inflation risks, further dimming the chance of a hike before August.

Its Monetary Policy Committee split 6-3 again in favour of holding rates at 0.5 percent, minutes of its April 6-7 meeting published on Wednesday showed, saying the medium-term outlook for inflation had not changed enough to alter their view.

Although the minutes said the near-term path of inflation was likely to be higher than the Bank forecast in February, the extent of the recovery from the slowdown at the end of last year was still unclear.

The minutes dropped the line used in March that some of those in favour of steady rates thought the case for a hike had increased. This month, they said news on demand and activity over the month had probably been to the downside.

"The dovish tone of the minutes has further reduced the chances of a rise in interest rates at next month's meeting," said Vicky Redwood, economist at Capital Economics.

"If the recent weaker tone of the economic data is sustained, we still think that a rate hike this year can just about be avoided."

Interest rate futures rose as investors scaled back their expectations for a first post-crisis hike and Barclays, Citi and Nomura pushed back their expectations for the first rise to August from May.

That may still be too optimistic, as markets are now pricing in slightly above a 50 percent chance of a rise in August, and November futures are just pricing in a full quarter-point hike.

FRAGILE RECOVERY

The BoE has kept rates at a record low for more than two years, in contrast to the European Central Bank, which raised borrowing costs this month for the first time in almost two years.

But those on the MPC who want to hold rates are worried that tightening policy at a time when consumer demand is so weak could derail Britain's fragile economic recovery.

Analysts are waiting for preliminary data from the Office for National Statistics on April 27 to see how strongly the economy rebounded in the first three months of this year from its unexpected 0.5 percent decline at the end of 2010.

The minutes said it was still too early to tell whether that slowdown was temporary or whether soft data on household spending heralded more protracted weakness in consumption.

"An increase in Bank rate in current circumstances could adversely affect consumer confidence, leading to an exaggerated impact on spending," the minutes said.

The MPC noted that while British services and manufacturing firms showed reasonably healthy growth, the volatile construction and energy sectors were likely to depress growth in the first quarter and complicate the outlook.

Retailers have also been hit by consumers' reluctance to spend due to higher taxes, rising prices and weak wage growth.

Supermarket chain Tesco said this week it failed to meet its UK profit expectations for the last year and expected conditions to remain challenging. On Wednesday, Home Retail, Britain's biggest household goods retailer, said it would face a hard time at least this year.

The minutes said that despite a drop in inflation to 4 percent in March, there was still a significant risk inflation would exceed 5 percent -- reinforcing the case of Andrew Sentance, Martin Weale and Spencer Dale, who wanted rate hikes.

But there are no signs yet that persistently high inflation is becoming embedded in the national psyche.

Data last week showed average earnings growth running at half the current rate of inflation and a survey by Citi showed Britons' inflation expectations for the year ahead logged their biggest monthly fall in almost six years in March.

"With growth in pay settlements showing no signs of taking off, we believe that an increase in interest rates in the next couple of months would be premature," said Nida Ali, economic adviser to the Ernst & Young ITEM Club.

"GDP in Q1 appears likely to disappoint, and with the March inflation figures being unexpectedly soft, interest rates are likely to remain at 0.5 percent for some time yet."

(Editing by Hugh Lawson)