Bank set to hold interest rate despite inflation threat

It is not a foregone conclusion, however. Some policymakers are growing increasingly nervous about the threat of inflation, and three of the nine-strong Monetary Policy Committee voted to raise interest rates in February.

Markets are pricing in a 10 per cent probability of a rate rise this week, half the chance they ascribed for a move in February, which would have coincided with the BoE’s quarterly economic forecasting round.

Nonetheless, investors will be nervous. Oil prices have surged to two-year highs above $117 a barrel and the European Central Bank has already signalled it is likely to raise rates this month, despite an inflation rate well below Britain’s.

Consumer price inflation in Britain hit four per cent in January, almost twice the euro zone’s 2.4 per cent, and is still rising.

The key argument for keeping UK interest rates on hold is the weakness of the economy.

Unlike its main trading partners, Britain suffered a shock 0.6 per cent contraction in the final quarter of last year. While surveys suggest the manufacturing and construction sectors have both recovered, the country’s dominant service sector is still struggling.

Investec economist Philip Shaw said: “Given the considerable downside risks, raising rates too early could prove to be a catastrophic misjudgment.”

The Bank of England, led by Governor Mervyn King, may be particularly wary of rocking the boat just weeks before the Government’s March 23 Budget.

Since it was made independent in 1997, the BoE has only ever made one monetary policy change in the month of March and that was two years ago when it slashed rates to 0.5 per cent and launched its unprecedented quantitative easing programme.

The Government announced a draconian four-year fiscal tightening programme last year but the bulk of the fiscal pain has yet to come.

Most investors are betting the BoE will keep its powder dry until May or June, when its decision will be informed by a preliminary estimate of first-quarter GDP and a new set of growth and inflation forecasts.

Money markets are fully pricing in around a 75 per cent chance of a quarter percentage point rate hike in May, with the likelihood of two more before the end of the year.

Many economists have brought forward their rate rise forecasts in recent months.

Vicky Redwood at Capital Economics said: “Continued uncertainty about the underlying strength of the UK recovery should prompt the Monetary Policy Committee to keep interest rates on hold.”