Bank of England keeps rates on hold at 5%

6 August 2008
The Bank of England has kept interest rates on hold at 5% for the fourth month in a row.

The decision by the central bank’s Monetary Policy Committee – which meets every month to discuss interest rates – was widely expected by economists.

However, the combination of soaring food and fuel prices and weakening economic growth will have posed a real dilemma to the rate-setters.

The government’s official measure of inflation - the consumer prices index - rose to 3.8% in June, nearly 2% above target and the highest level since May 1992. Some analysts even predict that inflation could breach 5% by the end of the year, piling even more misery on hard-up families struggling to cope with the rising cost of living.

Although a rate rise would help to bring inflation under control, the UK’s economy is grinding to a halt. Earlier this week the Office for National Statistics reported that the economy grew by just 0.2% over the past three months - the UK's worst quarterly growth figure since the second quarter of 2001.

And it’s bad news for the high street too – the Chartered Institute of Purchasing and Supply recently posted a third consecutive month of declining activity in the service sector. In addition, the Nationwide’s August consumer confidence index reported that overall consumer confidence fell by 18% from July and is 46% lower than a year ago.

Howard Archer, chief economist at Global Insight, believes that all of these signs point to a recession. “With the economy contracting, it looks increasingly likely that a recession will be here by the third and fourth quarter of this year,” he says. “Growth will be flat at just 0.4% throughout 2009, meaning the Bank of England will actually have to make cuts in interest rates to spur the economy.” Archer predicts that the MPC will have to make gradual cuts throughout next year, which could see interest rates reach a low of just 3.5%.

Vicky Redwood, a UK economist at Capital Economics believes the MPC is will adopt a ‘wait-and-see’ approach for the rest of this year. “The Bank is waiting to see what the inflation expectations are over the long-term, until this becomes clearer the MPC will be content to sit tight.”

The nine-member committee was split three ways when they left interest rates unchanged at 5% last month, reflecting the dilemma they face by juggling weak economic growth with rising price pressures.

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