UPDATE: Bank Of England Leaves Key Rate Unchanged At 5%

By William L. Watts

LONDON (Dow Jones) -- The Bank of England's Monetary Policy Committee on Thursday voted to leave its key lending rate unchanged at 5% for the fifth consecutive month, as the central bank remains boxed in by a combination of rising prices and sputtering economic growth.

While a rapidly deteriorating economic outlook has virtually eliminated prospects of a rate hike, economists said, policymakers have made clear they want to see convincing evidence that inflation - and inflation expectations - have peaked before easing rates.

"This decision did not come as a surprise; though the economy has ground to a halt, the bank remains wary of cutting rates while inflation continues to rise," said Andrew Goodwin, senior economic advisor to the Ernst & Young ITEM Club.

"Oil prices may have dropped 25% from their highs in July, so any worries that the Bank might actually need to raise rates have all but disappeared, but it would have been premature to cut today," agreed Martin Slaney, head of derivatives at GFT. "The next move from the bank is almost certain to be a cut but we may well have to wait until November or December."

The dilemma created by rising inflation and deteriorating growth had split the rate-setting MPC as recently as August, when member David Blanchflower repeated his call for an immediate rate cut and member Tim Besley voted for an anti-inflationary rate hike while the remaining seven members, including Bank of England Gov. Mervyn King, voted to remain on the sidelines.

Details of Thursday's vote won't emerge until the minutes of the MPC meeting are released on Sept. 17.

The British pound rebounded from its recent plunge ahead of the decision and remained 0.3% higher against the U.S. dollar at $1.7796 after the decision. The pound, which had notched a record low against the euro earlier in the week, was up 0.5% against the European single currency to 81.20 pence.

London's FTSE 100 stock index was little changed following the decision, holding a gain of 0.5% to 5,528.50.

In Frankfurt, the European Central Bank also opted for a steady approach, leaving its key interest rate on hold at 4.25%.

MPC members began the two-day meeting Wednesday amid an ongoing drumbeat of disappointing economic data and deepening gloom.

U.K. Chancellor of the Exchequer Alistair Darling said in a weekend newspaper interview that the country faces "arguably the worst" economic conditions in 60 years, an interview that put severe pressure on the U.K. pound.

The pound has fallen sharply since trading above $2 against the U.S. currency as recently as July, plunging to $1.77, a level not seen since April 2006. Against the euro, the pound has tumbled to all-time lows.

Recent official data showed that the economy stalled in the second quarter, producing no growth in gross domestic product and ending 64 consecutive quarters of expansion.

The Organization for Economic Cooperation and Development on Tuesday said the U.K. will fall into a recession this year.

On Thursday, the Halifax house price index showed a 1.8% slump in August, bringing house prices 10.9% below levels seen in August 2007. The annual decline was the steepest since the survey began 25 years ago, Halifax said.

House prices, which had seen a sharp run up in recent years, have plunged as credit conditions have tightened and worries about the economic outlook have risen.

Meanwhile, consumer price inflation remains well above the central bank's 2% annual target, hitting 4.4% in July after a 3.8% reading in June. Despite a pullback by oil prices, consumer inflation is likely to rise further in coming months.

Moreover, MPC members have worried that commodity-led inflation pressures will become entrenched in the economy unless consumers, price-setters and wage-negotiators are convinced the central bank won't let inflation rise over the long term.

Declines in inflation expectations have likely assuaged those worries somewhat, wrote Michael Saunders, head of European economics at Citigroup.

Policymakers, however, are unlikely to begin cutting rates until they see solid evidence that inflation and inflation expectations have peaked -- something that's unlikely to arrive until at least the fourth quarter and may not clear the way for rate cuts until 2009, Saunders said.

(END) Dow Jones Newswires

September 04, 2008 10:17 ET (14:17 GMT)


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