Inflation hawks outvoted as rates remain at 0.5 per cent

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The monetary Policy Committee of the Bank of England kept interest rates at a record low of 0.5 per cent yesterday, but the decision to maintain the level for a 17th consecutive month masks disagreement over whether to lift the borrowing rate to tackle rising inflation.

The decision to hold rates was widely expected, but with consumer price inflation at 3.2 per cent, well above the Bank's target rate of 2 per cent, set by the Government, certain MPC members have called for rate rises. Andrew Sentance has already voted twice for a 25 basis point rise, and had indicated that he intended to do the same during this month's meeting, earlier this week. Minutes from this week's meeting will be published on 18 August.

So-called hawks like Mr Sentance were outvoted by other MPC members, who believe that inflation is not high enough to offset the need for low rates to support the economic recovery. "There... seems to be a growing movement advocating an increase in interest rates," said Jennet Siebrits, head of residential research at property advisers CB Richard Ellis.

"The trouble is that it is all a very fine balancing act. Increasing interest rates in response to the stronger than expected recovery and to mitigate inflation is a logical argument, but, as the doves point out, the effects of the emergency Budget are still permeating the economy, so by pumping more money into the economy the MPC could actually be safeguarding the recovery."

As usual, there was no statement by the MPC to accompany the decision, leaving the City waiting for next week's Inflation Report to decipher the thinking behind yesterday's decision.

In past reports, the Bank has blamed the weakness of sterling and spikes in commodity prices for higher than expected prices, a phenomenon that economists expected would be dampened by spare capacity in the economy, indicated by high unemployment. In recent months, however, several members of the MPC have cautioned that inflation could remain close to its current levels, or even increase, possibly until the end of next year.

In an interview with The Independent last month, Spencer Dale, the Bank's chief economist, said: "Since the spring of 2006 inflation has been above target for 41 out of 50 months and for two years it has averaged over 3 per cent. Now, we can come up with all sorts of clever reasons to explain our view, but at some point people will say 'inflation just seems to be higher than it used to be' and that is a very substantial risk."

Mr Dale is considered to be a cautious member of the MPC, and although inflation is making those calling for a rate increase more vocal, the majority of the committee are satisfied that there is a large enough risk of the economy slipping back into recession to justify keeping rates low.

George Osborne, the Chancellor of the Exchequer, has indicated that he expects monetary policy to be used to deal with any softening of the economy as a result of government spending cuts – expected to be as high as 40 per cent in some departments. Mr Osborne has implied that policies, such as the VAT increase to 20 per cent, which comes into effect next January, will not be reversed even though it immediately led to a spike in inflation.

Recent company announcements have warned that the fragile economic recovery is under pressure, despite last month's unexpectedly strong growth of 1.1 per cent.

Last week, the Bank's Governor, Mervyn King, argued that keeping rates low was essential for growth: "We [need] to keep our foot firmly on the accelerator to stimulate the economy. The debate is about the appropriate degree of stimulus, not about applying the brakes."

The MPC's quantitative easing programme was also maintained at £200bn yesterday, with the recent bullish GDP figures convincing the committee that low rates alone were enough to keep the economy on track for now.