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BoE likely to hold interest rates

BoE likely to hold interest rates

LONDON, July 10 (Reuters) – The Bank of England is expected to hold interest rates at 5.0 percent on Thursday and will probably sit tight until it has a better idea of which is the greater evil, surging inflation or slowing economic growth.
Inflation is running at its fastest pace since the BoE won the power to set British interest rates in 1997, a development that would embarrass any inflation-targeting central bank.
The European Central Bank has already raised borrowing costs to counter the global inflation threat and British policymakers, who are required to keep inflation at 2 percent, say they won’t be surprised if it spikes above 4 percent this year.
In any other circumstances, UK rates would be going up but doom-laden economic news has been coming in thick and fast. This has raised fears of the first British recession since the early 1990s and persuaded all 72 analysts polled by Reuters that borrowing costs will stay on hold this week.
The UK housing market is spiralling downwards, stock markets are tumbling, firms are laying off thousands of workers and surveys already indicate the economy is shrinking.
“The UK is heading for a toxic mix whereby CPI inflation heads up to about 5 percent in the next two to three quarters while the economy skirts with — or may well fall into — recession,” said Michael Saunders, an economist at Citi.
CALLS FOR CUTS
Business groups have turned up the volume on their routine calls for the BoE’s Monetary Policy Committee to lower interest rates, and they have found an ally in the trade union movement.
“We are at a dangerous point when businesses are starting to act like a recession is due,” said Adam Lent, economics spokesman at the Trades Union Congress. “This behaviour risks creating serious problems no matter what the economic reality.”
“A rise in interest rates would be catastrophic. A hold would do little to calm nerves. The Monetary Policy Committee needs to send a clear message that it is doing all it can to ease the credit crunch by cutting rates,” he said.
The economy is undoubtedly slowing and Britons seem in danger of talking themselves into a recession, but the “economic reality” does not yet appear bad enough to force the central bank to slash interest rates.
Retail sales figures, although disputed by some economists, have been remarkably strong this year and a weaker pound is expected to help to rebalance the economy towards exports and boost the manufacturing sector.
In any case, the BoE says it wants to see growth slow to help cool inflation — which it says is being made worse by forces out of its control such as oil and food prices.
However, if the economy slows too sharply and starts to contract, inflation may undershoot the target.
While financial markets have scaled back their hawkish outlook, they remain far from convinced that rates will fall.
But if the data continues on the current bleak path, the risk of a recession — two successive quarters of contraction in GDP — should result in lower borrowing costs, analysts say.
“We expect muted consumer spending to increasingly dilute retailers’ pricing power and ultimately facilitate further interest rate cuts,” said Howard Archer at Global Insight. “However, given current inflation levels and risks, the Bank of England may well be reluctant to cut interest rates until 2009 unless the economy really falls off a cliff.”
For now, economists believe policymakers are in ‘wait and see mode’, aware that a move in interest rates either up or down now may well come back to haunt them.
 
 

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