Bank set to leave interest rates on hold

Evidence of weak consumer demand and the slowing housing market is likely to stay MPC's hand
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The Independent Online

Interest rates are expected to be left on hold when the Bank of England's Monetary Policy Committee meets later this week, despite growing evidence of a sustained return to reasonable levels of economic growth.

Few City economists expect the Bank to respond to more positive economic news by raising interest rates just yet. The last rise was in November, when the repo rate was increased by 0.25 percentage points to 3.75 per cent.

Evidence of weak consumer spending in the run up to Christmas, together with confirmation that the housing market is at last starting to slow, is thought likely to persuade the MPC to stay its hand, for the time being at least. However, there is a high degree of expectation of further rate rises later in the year, as growth returns to more normal levels.

This week's MPC meeting is the first to be governed by the switch to a new inflation target under the Consumer Price Index, which uses a more internationally recognised way of calculating inflation. Under this measure, inflation is just 1.3 per cent, way below the new inflation target of 2 per cent.

Even so, this is not thought likely to deter the MPC from raising rates over the months ahead. The Bank sets rates to target inflation two years out, when prices are expected to be close to or above target.

A business trends report from the accountants BDO Stoy Hayward, published yesterday, shows business optimism and output at its highest levels since May 2000. The findings mirror Friday's CIPS purchasing managers' index, which suggested manufacturing was expanding at its fastest rate in more than four years.

But although most economists expect business growth to accelerate over the months ahead, the Chancellor's forecast of 3 to 3.5 per cent growth for the coming year is still generally thought too optimistic. The BDO optimism index, based on a poll of businesses, indicates annualised growth of only 2.3 per cent in the second quarter of this year.

Nonetheless, a marked turnaround in business and investor confidence has established itself in recent months. According to a survey by Bloomberg News, brokerages expect the renewed strength in equity markets to continue this year. The survey of 14 securities firms points to an average rise of 8 per cent in benchmark indices for 2004.

Steve Bell, chief economist at Deutsche Asset Management, cautioned that although "things still look good for 2004, investors around the world have started the year in optimistic mood and companies will have to work hard to beat expectations".

The big unknown for the UK economy is the extent to which consumers will rein in their spending to pay down high levels of debt. Figures due to be announced this week by the Retail Motor Industry Federation show that new car sales hit another record of 2.57 million units last year, boosted by low interest rate deals and intense price competition.

Bank of England figures released last week showed that equity withdrawal, where householders borrow against the value of their properties to finance consumption, was close to its all-time high of 7 per cent of disposable income in the third quarter of last year.

Economists are divided over the sustainability of Britain's borrow to consume economy. The Bank of England is concerned that if the credit boom is allowed to go unchecked for too long, it may eventually result in a serious demand shock to the economy when interest rates rise to counter inflationary pressures.

Despite these concerns, most economists expect interest rates to remain subdued for most of this year. Few City economists are thinking the repo rate will rise to more than 4.5 per cent by the end of the year.