Bank holds rates at record low

Click to follow

The Bank of England left interest rates at their record low today despite fears over surging inflation and commodity prices.

Policymakers kept the base rate at 0.5% for the 22nd month in a row even though consumer price index (CPI) inflation hit 3.3% in November, driven by the rising cost of food, clothes and oil.

The Bank also maintained money-boosting efforts under the quantitative easing programme at £200 billion.

The Bank's policy setters, who are tasked with keeping CPI at 2%, have admitted that inflation could rise to 4% in the spring but the rise would be temporary and fall back next year.

The feeble nature of the economic recovery means the Bank would rather brave above-target inflation than risk tipping the economy into a "double-dip recession".

Putting up interest rates might help reduce inflation but it would also restrict the spending power of homeowners with tracker mortgages and people repaying other debts, which would further endanger the recovery.

Consumers' spending power is being squeezed because pay packets are not keeping up with inflation.

There has been a barrage of bad news for cash-strapped consumers in recent weeks as petrol, gas and clothes all rose in price, and last week's VAT rise from 17.5% to 20% pushed up the cost of most goods and services.

Prime Minister David Cameron told the BBC this week that inflation was "concerning" and "well outside what the Bank is meant to deliver".

Monetary policy committee (MPC) member Andrew Sentance has repeatedly called for gradual interest rate rises to stave off the rising threat of inflation.

But the consensus of the committee is that most of the inflationary pressures should fall away in a year's time.

And there are concerns over the strength of the recovery, which weakened in December, hindered by the Arctic weather.

Markit/CIPS data showed that the construction sector fell further into decline in the month, while the powerhouse services sector contracted marginally for the first time in 20 months, leaving only the manufacturing sector in growth.

GDP figures for the second and third quarters were also revised down from 1.2% to 1.1% and from 0.8% to 0.7% respectively, adding to fears over the strength of the recovery.

Markit economists say the recovery had "near-stagnated" and expect the UK's GDP growth in the fourth quarter of 2010 to be just 0.4%.

British Retail Consortium figures released earlier this week showed sales in December were at their worst for eight months as the snowy weather and money worries caused shoppers to cut back on buying presents.

Economists disagree on when interest rates, which have been at their current level since March 2009, will rise.

Last month, the CBI warned that rates would start to rise by the spring and the base rate would hit 2.75% by the final quarter of 2012.

Economists are slowly bringing their predictions of when interest rates will rise forward as inflation grows.

Howard Archer, chief economist at IHS Global Insight, said: "The Bank of England is currently in a really difficult position, caught between an inflation rock and a growth headwinds hard stone.

"We suspect that most MPC members will favour keeping monetary policy unchanged in the near term at least while they look to see how much the economy is being affected by January's VAT hike and the fiscal squeeze increasingly kicking in."

He said the Bank was unlikely to put rates up before the fourth quarter of 2011, although there was a chance they could go up slightly as soon as next month, as a gesture that inflation is being taken seriously.

Philip Shaw, chief economist at Investec, estimates CPI could rise as high as 4.5% this year if the full effect of the VAT rise is passed on to consumers rather than absorbed by retailers and other businesses.

Inflation could also stay above target in 2012 if commodity price hikes linger, he added.

Mr Shaw said: "The inflation background looks increasingly uncomfortable over the next two years and the committee's credibility is at stake.

"But raising the Bank rate from its current level of 0.5% risks sending the recovery into reverse."

With the economy being too weak to stand a substantial interest rate hike in the near future, he suggests the Bank could start to reverse some of its quantitative easing programme as a way of fighting inflation.

CBI chief economic adviser Ian McCafferty said: "While this 'hold' announcement is not a surprise, decisions in the coming months will be more difficult as the Bank's anti-inflation credibility comes under greater pressure.

"Global commodity prices are rising, pushing inflation upwards, and after two years of pay restraint earnings growth is also likely to edge higher over the months ahead."

He expects the MPC to nudge up interest rates before mid-2011 if the current economic trends continue.