April 6, 2011 / 11:17 PM / 9 years ago

Bank set to keep interest rates at record low

LONDON (Reuters) - The Bank of England is almost certain to ignore criticism that it has gone soft on inflation and leave interest rates at a record low on Thursday due to uncertainty about the strength of Britain’s fragile recovery.

Inflation is running at 4.4 percent — more than double the target — and critics accuse the central bank of risking its credibility by refusing to tighten policy to control spiralling prices.

While the British economy is forecast to have bounced back in the first quarter after a shock contraction late in 2010, economists expect the Bank to wait for more signs of recovery before raising the cost of borrowing.

All but one of 67 economists polled by Reuters expects the Bank to leave its key rate at 0.5 percent on Thursday, where it has been since March 2009.

“The case for holding fire on interest rates for now at least is supported by still serious uncertainties and concerns about the underlying strength of the UK economy and its ability to withstand the increasing fiscal squeeze,” said Howard Archer, chief European and UK economist at IHS Global Insight.

The Bank’s rate-setting Monetary Policy Committee said last month that the recent rise in oil prices, fanned by tension in the Middle East and North Africa, had increased adverse risks to both inflation and growth.

Money markets show just over a 10 percent chance the Bank will raise rates on Thursday, and a 60 percent chance of a rise in May.

ECONOMIC HEADWINDS

The economy faces strong headwinds from the impact of government spending cuts, tax rises and low wage growth, which are all likely to undermine domestic demand.

With many households feeling the pinch from higher prices, the Bank has faced growing calls to do more to curb inflation.

However, Bank Governor Mervyn King said last month it would be “self-defeating” to raise rates merely as a gesture to show it was taking inflation seriously.

A majority of Bank policymakers joined him in voting against a rate rise last month, judging that the risk of choking growth by raising rates is more serious than the effects of inflation.

At March’s meeting, six members of the nine-strong Monetary Policy Committee voted to leave rates unchanged, Spencer Dale and Martin Weale wanted a 25 basis point hike, and Andrew Sentance voted for a 0.50 percent rise.

Minutes from that meeting showed the MPC feared inflation could soon exceed 5 percent, although they also noted consumer spending had “deteriorated sharply.

The economy’s unpredictability was brought into focus this week with two starkly contrasting sets of data.

Figures on Wednesday showed industrial output unexpectedly suffered its biggest fall since August 2009 in February. A survey the day before showed the dominant services sector picked up in March to grow at its fastest pace in more than a year.

More dovish members of the Bank fear that a premature interest rate rise could cause future inflation to undershoot its target, due to risks to growth from public spending cuts, and squeezed household incomes. By contrast, the European Central Bank is seen raising rates on Thursday.

Wavering Bank policymakers may also want to wait for the release on April 27 of first quarter GDP figures before any hike. While a positive reading would be welcome, it may not tell the whole story about the UK recovery, an academic think-tank said in a report on Wednesday.

The National Institute of Economic and Social Research (NIESR), which produces monthly GDP estimates, said its estimate for a 0.7 percent first quarter rise in GDP was flattered by the impact of bad weather at the end of 2010.

“The underlying growth rate is weak. The average rate of growth in the final quarter of last year and first quarter of this year was 0.1 percent,” it said.

Editing by Hugh Lawson

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