Inflation fears dampen prospect of Bank cutting interest rates

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The Independent Online

Hopes of a spring cut in interest rates faded yesterday after it emerged that just one of the nine members of the Bank of England's Monetary Policy Committee had voted to lower borrowing costs earlier this month.

It was the third successive month for an eight-one vote and demolished a last-minute flurry of speculation that the vote could be as close as five-four.

The minutes of the meeting on 8 and 9 February adopted a hawkish tone, warning that a rate cut could push up inflation by boosting house prices and consumer spending at a time when GDP was rising. The tone was echoed by a report from the CBI, the employers' federation, which showed manufacturers enjoyed a sharp new year rise in orders and optimism.

"There is currently no movement towards a rate cut," said Jonathan Said, an economist at the Centre for Economics and Business Research (CEBR).

"The Bank is predicting an economic recovery this year and it has plenty of evidence to support its argument."

The minutes of the two-day MPC meeting showed most MPC members thought the near-term outlook for consumer spending was stronger than envisaged in November.

"There was some concern that a reduction in rates at this stage would provide further support to the housing market and consumption at a time when GDP growth was already strengthening," the minutes said. "That would increase the probability of inflation rising above the target in the medium term."

Stephen Nickell, the lone advocate for a rate cut, said there was a case for an "immediate" reduction. He said weak GDP growth, rising unemployment and surveys of capacity use pointed to spare capacity in the economy. The two sides split over inflation, with Professor Nickell forecasting it undershooting the 2.0 per cent target but the majority saying soaring gas prices were likely to push up inflation to a higher extent than previously thought.

Alan Clarke, a UK economist at BNP Paribas, said: "The split remained but the dynamics have shifted. Sentiment is clearly evolving away from sympathising with the idea of lower interest rates and the arguments for one are wearing thin."

The minutes noted the housing market had been stronger than expected, while survey data suggested that economic growth would strengthen a little in the first three months of 2006. Most members felt GDP growth would pick up gradually, though with the "balance of risks on the downside", while the future path of energy prices was uncertain.

Some analysts said that the Bank's hawkish tone was based on the bullish forecasts it published in last week's quarterly inflation report, that might be too optimistic. Rob Carnell, an economist at ING Financial Markets, said: "Against the backdrop of rapidly rising utility bills, potentially higher taxes - especially local taxes - and rising unemployment, these projections look unrealistic to us."

The pound fell against the dollar as traders said that the Bank had delayed rather than cancelled a cut in interest rates while the US Federal Reserve was still poised to continue tightening monetary policy.

The CBI's survey of 785 manufacturers found that order books had improved to their best level since March last year. As a result, firms predicted a modest increase in output over the coming months.

It said 18 per cent reported order books above normal while 36 per cent said they were below - a balance of minus 18 compared with an average of minus 26 per cent over the previous six months.

"This survey provides encouraging news," said Ian McCafferty, the CBI's chief economic adviser. "If expectations are realised, the decline in output through 2005 may finally be coming to an end."

In the City, Paul Dales, UK economist at Capital Economics, said the survey pointed to a decent" manufacturing recovery. "This supports the MPC's view that GDP growth could soon move back above trend," he said.

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