Bank keeps interest rates unchanged

The Bank of England today held interest rates at 3.75% for a second consecutive month after the continuously-growing housing market appeared untouched by last month's 0.1% fall in inflation.

The Bank's nine-member monetary policy committee - which last increased rates, by a quarter-point, in November - appeared to have delayed an inevitable decision on raising them until February, when it can take new inflation figures into account.

Analysts said that keeping rates on hold this month would also allow the MPC to assess whether the strong run of economic data towards the end of last year was being sustained into 2004.

Data from the services industry showed the sector growing more slowly in December than it had in November, but still expanding at a level consistent with healthy output growth.

Retail figures from the CBI were also strong, showing a sharp pick-up in sales last month.

However, a major reason for a rise in interest rates lies in the still-strong UK housing market.

Earlier this week, figures showed house prices across the UK jumping by an average of 1.8% during the final month of last year, demonstrating that November's slight rate rise had little impact on the market.

Two months ago, the Bank made its first increase in the cost of borrowing for almost four years, lifting rates from a 48-year low of 3.5%.

However, small rate rises have little effect on the housing market, with a 0.25% rise adding roughly ?4 per week to a typical ?80,000 mortgage. In November, UK house prices rose by 1.2%; the smallest rise since June.

Furthermore, a rate rise never looked likely today following December's surprise fall in inflation.

Last month's drop in the consumer prices index - the government's new target inflation measure - to 1.3% means that inflation has undershot the government's new target of 2% in every month since May 1998. It stands at its lowest since the 1.1% of June this year.

The Bank is also under pressure from unions and manufacturers to keep rates low because of the still-fragile manufacturing recovery.

David Frost, the director general of the British Chambers of Commerce, welcomed the decision to hold rates, urging the MPC to keep them down.

"A trend of rising interest rates in the coming months would worsen the already tough conditions affecting the manufacturing sector and might accelerate job losses," he said.

But with economic growth picking up and sterling remaining strong, many analysts today forecast future upward moves in interest rates and suggested that the MPC would increase rates to 4% as early as next month.

The government's recent change in the way it measures inflation added to uncertainty about the strength of consumer spending over the Christmas period and contributing to the MPC's decision to hold off a rate rise until February, Mike Taylor, of Merrill Lynch, said.

"Nevertheless, the UK economy is gathering momentum and the economy has limited spare capacity, so higher rates are inevitable," he added.