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LONDON (Thomson Financial) - The Bank of England could well issue its first statement alongside an unchanged interest rate decision in more than eight years today, relaying its view about the liquidity squeeze hitting the UK financial system.

Under normal circumstances, the central bank would only give a statement if there was a change in borrowing costs or if the decision came out of the blue. In this case, all 36 economists polled by Thomson Financial News expect the nine-member Monetary Policy Committee to leave its benchmark rate on hold at 5.75 pct.

However, the turmoil hitting the credit markets means many market players are calling for the bank to clarify whether its policy stance going forward has changed since the August Inflation Report.

"If there was ever an occasion the MPC might release a statement to accompany an expected no change decision then it is this week," said George Buckley, UK economist at Deutsche Bank.

Yesterday the BoE broke its silence on the liquidity crunch, when it said in its operational announcement that it was raising its reserves target for the next month by 6 pct, and was prepared to add an additional 25 pct if overnight interest rates stayed high.

In a statement the central bank said the increase should "relieve some pressure on interest rates of overnight borrowing which have, at times during the maintenance period over the past month, been unusually high".

However the BoE emphasised that the measures were not intended to narrow the spreads on longer-term lending between banks, such as the 3-month LIBOR rate which has risen more than a full-percentage point above the 5.75 Bank rate.

While this may go someway to addressing banks' short-term liquidity needs, markets will want to know what impact the credit squeeze has had on the BoE's economic outlook.

The Bank has faced increasing criticism from the City for staying decidedly quiet since the credit crunch began in early August, in sharp contrast to the US Federal Reserve and the European Central Bank.

"Relations between the BoE and the banking community are becoming strained," said ECU Group's chief economist Neil Mackinnon.

The last speech by an MPC member was by deputy governor John Gieve on July 24, well before the latest volatility started.

Until yesterday's brief announcement, the only official communication on policy from the BoE was the August Inflation Report and the minutes to that month's rate decision. Many analysts now believe assumptions in both these documents have been superceded by events.

Michael Saunders, UK economist at CitiGroup, said the Bank was probably wary of making any comment as it could easily be misinterpreted and "add to the confusion rather than reduce it".

"But while silence has been a valid tactic during August for the BoE, we doubt that it is a viable long-term option," Saunders added.

The rationale for the BoE to issue a statement would be that projections underpinning its Inflation Report may no longer hold.

The report on August 8 indicated that the annual rate of CPI inflation would only fall back towards the 2.0 pct target in two years time if rates rise once more in the next few months. Since then the credit crunch has pushed market rates significantly higher, and figures revealed annual CPI Inflation in July fell below target to 1.9 pct from 2.4 pct in June.

"If the MPC acts as if nothing has changed since the August Inflation Report, then markets might conclude that the MPC remains tilted to tighten

again even with the current market strains and this could create an undesirable further tightening in financial conditions," said Saunders.

The last time the bank issued a statement when rates were left on hold was in May 1999.

At that time, the pound had appreciated strongly since the previous Inflation Report and the Bank warned that if sterling did not weaken as assumed in the report, then interest rates could need to be cut further to avoid undershooting the inflation target. The following month the BoE cut interest rates a quarter point.

The only other occasion since the BoE's independence in 1997 when there was a statement on an unchanged rate decision was in September 1998 when the Russian financial crisis led to widespread volatility in financial markets.

Again the bank warned that it may undershoot its inflation target if the international economy deteriorated further and followed through the next month with a rate cut.

Robert Barrie, UK economist at Credit Suisse, said that in both statements the MPC has "effectively said that if something else doesn't change then policy will".

So, in the current scenario, unchanged policy would imply rates rising again in the coming months and a change would be to leave them on hold.

As for the wording of the statement, Barrie argues that it would need to highlight the risk the market turmoil poses to the wider UK economy.

"The statement could suggest that the present period of financial volatility would be likely to lead to slower growth if it were to be sustained for much longer," he said.

rachel.armstrong@thomson.com

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