Sterling rallies despite standstill on rates

The pound mounted a recovery yesterday as the markets bet that the Bank of England's decision to keep rates on hold had only postponed further tightening of monetary policy.

The pound mounted a recovery yesterday as the markets bet that the Bank of England's decision to keep rates on hold had only postponed further tightening of monetary policy.

The decision to leave interest rates at 6 per cent for the sixth month in a row was in line with market expectations. But some analysts said, that with little sign of a slowdown in the domestic economy, rates will have to rise soon to keep inflationary pressures under control.

Sterling's trade weighted index rose sharply, closing at 107.9 compared with 106.9 on Wednesday. It gained a halfpenny to 60.46p against the euro, and slammed the brakes on its fall against the dollar. It closed in London up 0.2 cents at $1.4962. The pound was also boosted by an across-the-board fall in the value in the euro, following the decision by the European Central Bank to leave rates on hold at 4.25 per cent.

Philip Shaw, UK economist at Investec, said there had been enough evidence to justify a rise: "There have to be clear signs of a deceleration in activity if a tightening is to be avoided."

Further evidence of the strength of the domestic economy came from a report yesterday showing the services sector continued to boom in July. Growth of new business, overall activity and employment accelerated last month, the Chartered Institute of Purchasing and Supply said. But it also showed inflationary pressures were still under control, with prices charged by services firms rising more slowly than input costs.

But Michael Derks, London-based economist with Commonwealth Bank of Australia, said he believed rates would stay on hold for the rest of the year. "The decision should be applauded as the case for a rate hike was not a strong enough one."

This view was echoed by business groups and trade unions, who said a rate hike would ended the fragile recovery in the manufacturing sector.

Economists must wait for the Bank's quarterly Inflation Report and the minutes of yesterday's rate meeting, published the following week, for firm clues on the path for rates.

They will look for the Bank's view on the likely impact of the Government's plan for a £43bn three-year increase in public spending. The minutes from the July meeting showed some of the nine-strong Monetary Policy Committe are worried rates will have to rise unless the private sector slows down. A powerful committee of MPs yesterday entered the debate, saying that the spending increases were "affordable".

"The overall spending totals have not changed since the Budget and we note that the MPC did not raise rates following the Budget," it said.