Bank holds interest rates at 5% as prices rise and growth stalls

The Bank of England held interest rates at 5 per cent yesterday as policymakers grappled with a combination of slowing economic growth and surging inflation.

The Monetary Policy Committee's widely forecast decision to keep borrowing costs on hold had little effect on the markets, which expect the next move to be upwards. Inflation is running at 3.3 per cent – the highest since the Bank was given the power to set rates in 1997 and way above the Bank's 2 per cent target. The Governor, Mervyn King, is keen to prevent the rising costs of food and fuel from locking inflationary expectations into the system.

He has said that this year will be the toughest so far for the MPC, and has predicted he will have to write more letters to the Chancellor, Alistair Darling, giving reasons why inflation is still above 3 per cent. But battling inflation for the long term constrains the MPC in keeping the economy afloat, as households and businesses try to cope with higher borrowing costs.

Consumer confidence fell to a record low last month. The British Chambers of Commerce says Britain is on the edge of recession and business morale has slumped. House prices are falling and housebuilders are cutting at least 4,000 jobs in an attempt to withstand the downturn.

Trevor Williams, the chief economist at Lloyds TSB Corporate Markets, said yesterday: "The Bank of England is facing the unenviable task of having to fix two different problems with just one policy tool. Britain hasn't yet reached recession but the worry is that raising interest rates could trigger this. Equally, not raising rates could risk even higher inflation later on."

The Bank of England has warned that inflation could hit 4 per cent this year, and most commentators expect the MPC, led by the hawkish Mr King, to raise rates again. Last week, the European Central Bank upped its rates for the first time in a year in an attempt to clamp down on inflation.

Charles Goodhart, a former MPC member, predicted that the severity of the downturn would force the Bank to cut borrowing costs whenever the next change came. "Output is going to fall, unemployment is going to rise, possibly quite sharply," said Mr Goodhart, a professor at the London School of Economics. "The economy is getting into quite a recession. It is a horrible situation."

The MPC's minutes are published on 23 July and are likely to show a split between policymakers as concerns over the twin threats of recession and inflation deepen.