Bank holds its nerve and keeps rates at 0.5 per cent as inflation bites

The Bank of England's Monetary Policy Committee defied its critics yesterday and kept interest rates at a 315-year low of 0.5 per cent; it also held its programme of quantitative easing – the direct injection of money into the economy – at the current £200bn.

The Bank's decision comes despite pressure to raise rates to curb rapidly rising inflation, and coincides with mixed news from the real economy. The Office for National Statistics reported weaker manufacturing output in December, partly due to the snow; energy output was up as demand for heating rose.

In its Inflation Report, due out next Wednesday, the Bank is widely expected to have to raise its inflation forecasts once again. On Tuesday the ONS will announce the inflation figure for January – likely to be as high as 4.5 per cent and to have triggered yet another open letter of explanation from the Governor, Mervyn King, to the Chancellor. Inflation will then have been more than one percentage point above the 2 per cent target for a year.

At the last meeting of the committee in January two members of the MPC voted for a rise in rates, the newest member, Martin Weale, joining the long-standing "hawk" Andrew Sentance in arguing for a 0.25 percentage point hike. One other external member, Adam Posen, argued for a further relaxation in policy and an increase in the quantitative easing programme. The majority – six – voted for no change in rates, which have remained at their current level since March 2009. The quantitative easing programme has been on hold since November of that year.

Markets anticipated that there would be no change and reacted calmly to the news. Speculation now centres on precisely when the Bank will announce the turning pointing in the interest rate cycle, with May, August or November – all of them "Inflation Report months" – emerging as the favourites. Much attention will be focused on the minutes of the meeting, which will be published in 10 days. So far the Governor has made it clear that he intends to "see through" the current spike in inflation, which has largely been caused by external events such as the rise in commodity prices and hikes in VAT.

So far there has been little evidence that such externally generated inflation has triggered the sort of wage-price spiral seen in the 1970s, for example. Even though expectations of higher inflation have edged up, few signs have emerged – apart from some skills shortages – that these are being converted into higher labour costs. Debate among economists centres on the extent to which there is spare capacity in the economy; this is difficult to measure and is rendered more opaque by the impact of the recession.

The "doves" on the MPC will have pointed to the shock contraction in GDP during the last quarter of last year, when output (discounting the snow) was flat. The National Institute for Economic and Social Research is set to say today that output in the UK economy is only as high as it was last July – indicating a far more muted recovery than normal – and that it has fallen 0.1 per cent in the last three months.

Yet business surveys, especially among manufacturers and exporters, suggest a more bullish outlook. The impact of the public spending cuts, meanwhile, has hardly begun.