BoE holds fire on rates, hike seen by mid-year

The Bank of England (BoE) kept interest rates at a record low of 0.5% on the view that Britain's economic recovery remains too weak to sustain an inflationary spiral, but investors still expect a hike by mid-year.

Thursday's decision was widely expected, but a small number of investors had bet on a rise and the pound slipped slightly after the announcement.

All but one of the 63 economists polled by Reuters last week had predicted a steady verdict. However, with inflation already double the BoE's 2% target, most expect the central bank to raise rates later this year.

The European Central Bank, dealing with a much smaller inflation problem, has already signalled that an interest rate rise in imminent.

However, there are strong arguments for the BoE not to raise rates just yet. Not only is Britain's economy more fragile than many of its peers, it also faces deep public spending cuts, the bulk of which have yet to kick in.

"The majority of MPC members likely decided that higher interest rates were an extra handicap that the economy could do without for now at least," said Howard Archer at Global Insight.

"The key question is will this prove to be a temporary reprieve on interest rates or will the Bank of England hold fire for some time to come? This remains a very hard call to make."

Waiting for clearer signals

The BoE is likely to want to see how the economy fared in the first quarter of the year before raising rates, particularly because data for the end of 2010 was distorted by Britain's most severe winter in a century. This means a rate rise before May is unlikely.

However, inflationary pressures are building and three of Britain's nine-strong Monetary Policy Committee voted to raise interest rates in February, so it would only take two to switch camps to get a majority.

"With the committee expected to begin tightening over the coming months, and a hike requiring the support of just two more members, UK markets look set to remain jittery," said Philip Shaw, an economist at Investec.

UK interest rates have stood at 0.5% since March 2009 when the BoE slashed rates to an all-time low and embarked on an unprecedented programme of quantitative easing.

The Reuters poll gave a median forecast that the central bank would raise interest rates by 25 basis points in the third quarter. Financial markets are fully pricing in the chance of a quarter percentage point rate hike by July, with another by October.

Thursday's decision will not have been unanimous. Andrew Sentance, the BoE's leading hawk, has been calling for a rate rise since last June and has recently been joined both by Martin Weale and BoE chief economist Spencer Dale.

A voting breakdown of this week's policy meeting will be published on March 23, the same day as the government's Budget.