Bank of England Holds Rate, Putting Recovery Before Inflation

The Bank of England kept its benchmark interest rate at a record low as policy makers judged the need to aid the recovery took precedence over the fastest inflation in more than two years.

The Monetary Policy Committee, led by Governor Mervyn King, set the key rate at 0.5 percent for a 26th month, as forecast by all 57 economists in a Bloomberg News survey. It also left its bond-purchase program at 200 billion pounds ($327 billion), as predicted by all 32 economists in a separate poll. The pound erased its gain against the dollar.

Policy makers are under increasing pressure to curb inflation that has soared to more than twice the central bank’s 2 percent target. Economists forecast the European Central Bank will announce its first rate increase since July 2008 later today. In the U.K., while three of the nine MPC members voted for tightening last month, most are waiting for evidence the recovery can withstand the government’s budget squeeze after the economy shrank in the fourth quarter.

“The pressure is building,” Ross Walker, an economist at Royal Bank of Scotland Group Plc in London, said in a telephone interview. “It’s certainly not a spectacular recovery, but there are persuasive reasons to start withdrawing some of the stimulus to guard against a bigger tightening in the future.”

The pound dropped as much as 0.2 percent after the decision. It traded at $1.6299 as of 12:23 p.m. in London, down from $1.6332 yesterday. U.K. gilts stayed lower, with the 10- year yield 2 basis points higher at 3.78 percent.

‘Close Call’

Walker forecasts a 25 basis-point rate increase in May, though it’s “a close call and the markets are going to be very data sensitive over the next month.”

While a report on April 5 showed that U.K. services expanded at the fastest pace in more than a year in March, the Office for National Statistics said yesterday that manufacturing growth stalled in February. At the same time, accelerating inflation is squeezing households, damping consumer spending.

U.K. gross domestic product rose 0.7 percent in the first quarter after a 0.5 percent drop in the previous three months, the National Institute of Economic and Social Research estimated yesterday. The group, whose clients include the Bank of England and the U.K. Treasury, said underlying growth remains “weak.”

The British Chambers of Commerce this week said first- quarter growth was probably between 0.6 percent and 0.7 percent. It said this is weaker than expected and adds to the argument that the Bank of England should delay raising its key interest rate, which has been at 0.5 percent since March 2009.

Growth Outlook

The government’s fiscal watchdog cut its 2011 growth forecast last month to 1.7 percent from 2.1 percent as the economic outlook is clouded by the government’s budget squeeze, unrest in the Middle East and the potential impact from the earthquake in Japan.

Tokyo-based Honda Motor Co. said yesterday it will slash production at its chief European factory in Swindon, England, by 50 percent for seven weeks to cope with a component shortage following the earthquake. Earlier today, the Bank of Japan held its benchmark at 0.1 percent in Tokyo.

As policy makers monitor the recovery, inflation has quickened to 4.4 percent, the fastest pace since October 2008. With prices for commodities such as oil and corn soaring, the Bank of England said last month there is a “significant risk” it will exceed 5 percent in the coming months.

Former policy maker Charles Goodhart said the bank should increase its key rate by 25 basis points because of the damage being caused by high inflation, the Times newspaper reported earlier today.

Central Bank Action

In the euro area, consumer-price growth accelerated to 2.6 percent in March, and the ECB has signaled it is ready to act. All 57 economists surveyed by Bloomberg see the ECB’s main rate rising to 1.25 percent from 1 percent when the central bank announces its decision at 12:45 p.m. London time. The rate may increase to 1.75 percent by year-end, based on the median estimate of 33 economists in a separate poll.

Sweden’s central bank in February raised its benchmark repo rate for a fifth time since July and signaled it will pick up the pace of monetary tightening. Poland’s central bank increased borrowing costs for the second time this year on April 5.

At the Bank of England’s March meeting, Andrew Sentance called for a 50 basis-point increase, while Martin Weale and Spencer Dale voted for a 25-basis-point move. Adam Posen maintained his call to expand stimulus with more bond purchases. The minutes of today’s meeting will be published on April 20.

Investors have priced in a 25 basis-point jump in the rate by July, according to forward rates on the sterling overnight interbank average, or Sonia, compiled by Tullett Prebon Plc.

“The MPC is in a very cautious mood, but it will have been a very close call,” Joost Beaumont, an economist at ABN Amro Bank NV in Amsterdam, said before the announcement. “I still hold on to the view they will hike in May. Data have been relatively upbeat recently.”

To contact the reporter on this story: Svenja O’Donnell in London at sodonnell@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net

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