No respite for savers as interest rates stick at 0.5%

8 July 2010

Interest rates were kept on hold once again in July despite high inflation proving to be a sticky issue for the Monetary Policy Committee (MPC). 

The headline cost of borrowing was frozen at its record low of 0.5% for the 17th consecutive month while the £200 billion quantitative easing programme was left untouched after drawing to a close in February. 

Last month, Andrew Sentence became the first MPC member to break rank and vote for a 25 basis point increase in rates. 

Howard Archer, chief UK and European economist at IHS Global Insight, said: "Sentance has consistently been one of the more hawkish members of the MPC and we just cannot see at least four more MPC members joining him in voting for higher interest rates in the near term at least (or three and Bank of England governor Mervyn King casting a deciding vote as Martin Weale does not join the MPC until the August meeting so there are currently only eight members rather than the usual nine)." 

He adds that three other MPC members - Paul Fisher, Adam Posen and David Miles - have indicated in recent speeches and articles that they are not ready to vote for an interest rate hike - at least not in the near term.

Edward Menashy, chief economist of Charles Stanley, says: "There are signs that the MPC is fragmenting into three camps. The Governor and Dr Sentance appear to be at different ends of the spectrum regarding the prospect of the CPI returning to target, whilst in the middle there are a variety of views as to whether the CPI will decline naturally." 

Economists are concerned that rising interest rates prematurely could strangle the fledgling recovery - despite inflation remaining stubbornly high. This stood at 3.4% in May - down from a 17-month high of 3.7% in April but still well above the Bank of England's medium term target of 2%.

However, there are signs this is starting to head down due to significant extra capacity and the waning of temporary factors including higher energy prices, sterling's past depreciation and VAT changes.

City commentators say the Bank's Quarterly Inflation Report, which is released on 11 August, will be greatly significant in revealing how the MPC assesses the various risks to both activity and inflation. 

Recent surveys have also suggested that growth in the dominant service sector is starting to tail off while the manufacturing sector could run out of steam in the second half of the year.

Economists are largely expecting rates to stay on hold for the remainder of the year.

Philip Shaw, economist at Investec, says: "The MPC will be very cautious over tightening until it is reasonably sure that the downside risks facing growth are largely neutralised. We continue to pencil in a modest rise in the first quarter next year and are targeting the Bank rate at 2% by end-2011." 

Archer adds: "We had expected interest rates to start rising in February 2011, but this looks questionable with the economy already set to be hit by VAT rising from 17.5% to 20% next January. So the first rate hike may well be delayed until the second quarter. 

"And when interest rates do start to rise, the increases are likely to be very gradual and limited due to the need to keep monetary policy loose to counter the major fiscal squeeze. Specifically, we see interest rates only rising to 1.75% by the end of 2011. 

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