February 10, 2011

Bank of England Holds Firm on Interest Rates

Says inflation risk is temporary but recovery is questionable

The Bank of England (BoE) on Thursday held the line on interest rates, keeping them at 0.5% despite money market expectations of a quarter-point rise. Economists had expected the rate to remain unchanged.

 As previously reported by AdvisorOne, the country’s economy was hit hard last month with the revelation that the GDP took a hit of 0.5% in Q4; it was also suffering from the impact of tax increases and stiff cuts in public spending. Concern over Britain’s recovery in the teeth of these challenges drove the decision to hold firm.

Reuters reported that the British government was hoping that a continuation of relaxed monetary policy would somewhat offset its austerity measures. However, the lack of change in the interest rate also may prompt criticism of the central bank for not taking action on price stability, as is its mandate. The rate of inflation in 2010 was more than a point above its target of 2%, and indications are that in 2011 it will go even higher as prices for commodities and oil drive the rise.

Mervyn King, the BoE’s governor, had cautioned in January that the rate of inflation could go as high as 5% in months to come. However, he added that he expected the country to be back on target in 2012 thanks to a quiet economy and without any further jolts to the system; last month’s sales tax increase drove inflation higher.

Two other members of the BoE monetary policy committee did not agree with King’s assessment, voting instead in January for an immediate interest rate increase of a quarter point.

Specifics of this month’s vote will not be available until Feb. 23.

Sterling fell briefly on the news; although it recovered much of its lost ground fairly quickly, it was still down as trading continued. March gilt and short sterling futures rose slightly and the FTSE barely reacted.

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