BoE expected to keep interest rates at 5%

The Bank of England is expected to frustrate households this week by leaving interest rates unchanged at 5% for another month.

Inflationary pressure caused by the rising cost of food and fuel means the Bank’s Monetary Policy Committee (MPC) will have no room to cut rates. That is despite mounting signs of economic weakness, as highlighted in recent days by consumer confidence data and a 2.5% monthly drop in Nationwide house prices.

Only a few weeks ago it seemed certain that rates would come down to 4.75% on Thursday. However, economists are now questioning whether there will be another cut this year after the Bank warned last month that Consumer Prices Index (CPI) inflation could spike as high as 3.7% this year.

The MPC is charged with keeping inflation at around 2%, but the measure is likely to remain above 3% until well into next year – prompting a series of open letters from Governor Mervyn King to the Chancellor explaining the rise.

A report presented by Mr King last month gave a clear impression that the Bank was unable to ride to the rescue of borrowers with a string of rate cuts.

He added that the economy was “travelling along a bumpy road” and called for patience until inflation returned to target.

But David Kern, economic adviser to the British Chambers of Commerce, said the Bank may regret not taking action if it elevated the risk of “a severe but needless economic downturn” later on.

He added: “The MPC must be forward-looking. If it is clear that the imminent increase in inflation is temporary, while plummeting growth would produce sharp falls in inflation later in the year and in 2009, the MPC must be prepared to cut rates without undue delay to limit damage to the economy.

“The priority must be to ensure that an unavoidable moderate slowdown does not degenerate into a needlessly severe downturn.”

The GfK NOP barometer of UK confidence scored minus 29 in May, down five points from April and the lowest reading since November 1990 – the start of the UK’s last recession.

It was the ninth month in a row that the survey’s confidence measure had fallen, with consumers battered by soaring petrol prices, household bills and declining house prices.

And a survey from the Nationwide Building Society suggested house prices fell 2.5% last month, the largest single drop in the 17-year history of the index.

Philip Shaw, chief economist at Investec Securities, said he believed a rate cut later this year still remained a possibility, given the impact of a weaker economic performance on inflation.

He added: “While interest rates are unlikely to come down soon, the economy is too fragile for the MPC to raise rates. Indeed the disinflationary forces stemming from weak growth still imply an easing in policy towards the end of the year.”

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