Bank of England set to hold interest rates

The Bank of England is set to hold interest rates at record lows today amid lingering doubts among rate-setters over a sustained recovery for the fragile UK economy.

The nine-strong Monetary Policy Committee (MPC) is unlikely to be swayed by the UK’s rapid 1.1% advance estimated between April and June, with growth expected to fade in the second half of 2010.

Economists expect the MPC to hold rates at 0.5% – where they have been since March 2009 – and leave its programme to boost the money supply unchanged at £200bn.

Rate-setters giving evidence to MPs on the Treasury Select Committee last week underlined their caution over the UK’s prospects, with Governor Mervyn King stressing a recent tightening in credit conditions and uncertainty over the world economy.

“We cannot be confident that the recovery in demand, output and employment here in the UK will be sustained,” Mr King said.

The Governor added that there was room to move in either direction and the debate was “about the appropriate degree of stimulus not about applying the brakes”.

Howard Archer, chief economist at IHS Global Insight, said: “The latest survey evidence showing service sector activity moderating appreciably in July and consumer confidence sinking to a 12-month low reinforces concern that the recovery will lose momentum over the coming months.”

The sole dissenter on the committee so far is Andrew Sentance, who is set to push for a rise for the third month in a row. He thinks the recovery is strong enough to withstand a gradual withdrawal of the emergency measures needed to tackle recession.

But the majority of rate-setters are still in favour of keeping the foot firmly on the monetary accelerator to compensate for the brutal cuts unveiled by Chancellor George Osborne to tackle the deficit.

The Bank’s latest forecasts – to be published next week – will almost certainly show slowing growth as a result of the Budget, although Mr King said the plans did not make a “significant difference” to the chances of a double-dip recession.

Mr Osborne’s VAT hike to 20% in January is meanwhile likely to keep inflation - currently at 3.2% – well above the Bank’s target for most of next year,

This will add to the pressure on households as wage growth lags behind, before a sluggish recovery drags prices down, ING Bank’s James Knightley said.

“Our base case remains subdued growth of the order of 1% to 2% over the next three years, which will continue to depress inflation pressures,” he said.