Bank holds rates steady as the recovery slows sharply

The British economy barely grew in December, according to the latest estimates from the country's oldest economics research body.

The National Institute for Economic and Social Research, which has a highly accurate record, says that GDP growth in December was negligible, leaving the rate over the three months to the end of the year at 0.5 per cent, down from 0.6 per cent in the three months to November. It is in line with the Office for Budget Responsibility's forecast, as used by the Treasury, and an early sign that the assumptions underlying the Government's plan to fix the public finances may be realistic.

The news came as the Bank of England kept interest rates on hold at the latest meeting of the Monetary Policy Committee, as universally expected.

The cold weather, says the NIESR, will have had only a "modest" effect, suggesting an underlying, but not catastrophic, slowdown as the initial boosts to growth from stock rebuilding fade.

Meanwhile, another group, the Centre for Economics and Business research (CEBR), has doubled the probability it places on a "double dip" from 10 to 20 per cent, and trimmed its growth forecast for 2011 to 1.1 per cent, against an official figure of 2.1 per cent, and consensus of 1.9 per cent.

One area of the economy that is strong is manufacturing. The Office for National Statistics said that the sector extended its recent record of output gains in November, albeit after the sharpest slump since the 1930s. Industry is set to record a 6 per cent annualised rate of growth during the last months of 2010, with survey evidence equally bullish for 2011. However, at around 13 per cent of GDP, manufacturing can only make a relatively small contribution to recovery.

The MPC faces a difficult dilemma. While the recovery lacks momentum, inflationary pressures have intensified from global commodity prices, and the Bank faces criticism for allowing its control of inflation to become "a joke". The Bank rate has stood at 0.5 per cent since March 2009, and the quantitative easing programme has been on hold for just over a year.

Opinion within the MPC on whether to start the next phase of the interest rate cycle sooner or later remains intense, despite the appearance of a calmly unchanged policy stance. The minutes of the MPC meeting will be published in 10 days; a definitive view will arrive with the next Inflation Report, on 16 February.

Most City economists expect the Bank rate to rise to 0.75 per cent at the August or November MPC meetings, with a few predicting May. Such an increase would add £40 a month to the average British mortgage bill, an unwelcome additional squeeze on households.

David Kern, the chief economist at the British Chambers of Commerce, said: "The recovery is fragile and risks of a setback are serious. Pressures on businesses and individuals will intensify over the next few months, but we urge the MPC not to overreact to temporary increases in inflation. As long as wage increases remain modest, and disposable incomes continue to be squeezed, it remains likely that the surge in inflation will be reversed, and sharp falls can be expected in the final months of 2011 and in 2012".

GDP data for the fourth quarter of 2010 will be released by the ONS on 25 January.

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