Interest rates on hold amid fears economy is stalling

Worst drop in growth since Lehman failure

The Bank of England kept interest rates at a record low yesterday after the economy suffered its biggest loss of momentum since the bankruptcy of Lehman Brothers triggered the global recession.

The Monetary Policy Committee's decision to put the weakening economy ahead of fears about inflation was widely expected after the gloomy data of recent weeks.

Yesterday's announcement of a slowdown in the all-important services sector reinforced the picture of a slowing economy after drops in manufacturing and construction growth. The three April PMI (Purchasing Managers Index) surveys suffered their largest drop since November 2008, just after Lehman went bust.

The dominant service sector grew less than expected in April after hitting a 13-month high in March. The Markit/Cips headline services PMI index slipped to 54.3 in April from 57.1 in March, staying in growth territory above 50.0 for a fourth straight month, but missing the 55.7 forecast.

The grim figures for April indicate the economy is slowing after the tepid 0.5 per cent growth in the first quarter of this year. Taken with the surprise 0.5 per cent contraction in the final quarter of 2010 the economy stagnated around the turn of the year.

The services survey highlighted the twin pressures faced by the MPC as it grapples with faltering economic growth and prices rising twice as fast as its 2 per cent target.

Average prices charged by services companies rose more steeply in April and registered the strongest reading since September 2008.

Markit's chief economist, Chris Williamson, said the hot April, volatile official construction figures, the royal wedding and the Japanese earthquake were among factors that confused the economic picture.

"This uncertainty, plus the modest rate of growth suggested by the PMIs, adds weight to the belief that policymakers at the Bank of England will err on the side of caution at the next two meetings at least, choosing to wait for a clearer picture of the pace of economic growth to emerge," he said.

All eyes will be on the minutes of the MPC's meeting in two weeks to see how the nine-strong committee split. Andrew Sentance, the MPC's resident inflation hawk, is expected to have voted again for a half-point increase in borrowing costs at his last meeting before leaving the committee.

But the bank's chief economist, Spencer Dale, and external member Martin Weale could have changed their positions in light of the recent grim data.

Mr Weale said two weeks ago he was disappointed by the economy's performance while Mr Dale has said his vote for a rate rise was based on growth returning to normal this year.

"The dynamics with the MPC could now change significantly, as the arch hawk Andrew Sentance is now leaving," The IHS Global Insight economist Howard Archer said: "We expect the BoE to delay raising interest rates... until November, and it is far from inconceivable that it could hold fire until 2012."

The Bank's Governor, Mervyn King, will present the Bank's latest set of quarterly economic forecasts next Wednesday. The MPC discussed the findings at this week's meeting.