Britain: On Inflation Alert, but Holding Fire

Signs of a stronger economy have shifted the Bank of England's focus to inflation. But before any interest-rate hike is made, the bank wants to see that manufacturing is back on track and recoveries elsewhere won't peter out.

At its May 9 meeting, the BOE's Monetary Policy Committee kept interest rates at 4%. In its subsequent May inflation report, however, the central bank said it "stands ready to act to contain any developing inflationary pressures further ahead." Real gross domestic product hardly grew in the first quarter, but the bank expects the economy to be rising near its potential long-term rate of 2.5% by the fourth quarter. Given the tight labor market, with April's jobless rate at only 3.2%, any pickup in growth will raise cost pressures.

In fact, price strains are already evident. Consumer inflation, excluding mortgage interest, was 2.3% in April, just below the BOE's 2.5% target. And service inflation alone is running at a high 4.5%.

Rising wages are fueling both consumer demand and inflation. Excluding bonuses, which have been cut back since late last year, compensation in March was up 4.4% from a year ago. Further increases could occur, given the tight labor market.

Solid pay growth, coupled with today's low interest rates, has also boosted the housing market. In April, home prices were up 15.1% from a year ago, and loan demand hit a record high.

Concerns about manufacturing will hold the BOE back, though, since an early rate hike could put a chill on business investment just as it is showing signs of improvement. Even so, March factory output slipped 0.8% from February. Manufacturing jobs are down 3.5% from a year ago, and orders remain weak.

The central bank also wants to make sure the recoveries in the U.S. and the euro zone, the largest markets for British exporters, have momentum. As a result, the BOE is unlikely to raise rates at its June 6 meeting and will wait instead until July.

By James C. Cooper & Kathleen Madigan

With James Mehring in New York

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