BoE Holds Rates on Inflation Fears

As food prices rise, the Bank of England keeps interest rates unchanged—to the dismay of retailers and industry

by Sean O'Grady

Fears of accelerating inflation as the price of commodities and foodstuffs continues to soar led the Bank of England to keep interest rates unchanged at 5 per cent yesterday.

The news disappointed retailers and industry. The Monetary Policy Committee cut rates by a quarter percentage point last month, and a series of weak data on economic activity this week had raised expectations that another "back to back" reduction was on the cards.

However, the price of crude oil has risen by almost a quarter since the beginning of the year, "soft" commodities such as rice continue to hit record high prices, and sterling has suffered a 15 per cent devaluation in the past few months, all factors that some members of the MPC have highlighted in recent speeches.

The Governor of the Bank, Mervyn King, has admitted that inflation will exceed 3 per cent later this year, at which point he will be forced to write a letter of explanation to the Chancellor of the Exchequer. Inflation has been at or below its 2 per cent target for only five months in the past two years.

What Mr King calls a "difficult balancing act" bet-ween controlling the inflationary spike hitting the economy this year and the risk of accidentally inducing a severe and deflationary recession next year has been symbolised by the development of an increasingly factionalised MPC.

David Blanchflower, a so-called "arch dove", said earlier this year that "worrying about inflation at this time seems like fiddling while Rome burns."

The picture is also complicated because inter-bank market lending rates, Libor, remain stubbornly high and insensitive to movements in official rates, because of the credit crunch.

There was no statement issued with the decision, as usual when rates are held, and analysts keenly await the publication of the MPC minutes in 10 days' time, and the Bank's definitive view of the state of the economy which will come in its quarterly Inflation Report next Wednesday. The possibility that the UK economy will slip into stagflation — stagnant output accompanied by high inflation — seems increasingly likely. While the MPC's decision came as no shock, some had hoped for a bolder approach. David Kern, an economic adviser to the British Chambers of Commerce, said: "We are disappointed but not surprised by this decision. We believe this decision was a mistake given the serious threats to economic growth. The MPC has missed a valuable opportunity to underpin business and consumer confidence and to limit the potential damage to the economy."

There is an almost unanimous hope and expectation that the Bank will cut rates to 4.75 per cent next month, with estimates for a nadir in the current rate cycle as low as 3.75 per cent this time next year.

Meanwhile, the European Central Bank kept its key rate on hold at 4 per cent, where it has stood since last June, as the ECB Council voiced concerns about inflationary pressures in the eurozone.

Provided by The Independent—from London, for Independent minds worldwide