Rates vote 8-1 on fear of divided economy

The Bank of England warned yesterday that the widening divide in Britain's two-speed economy could prevent it from cutting rates again for fear of sparking a resurgence in inflation.

The Bank's monetary policy committee voted 8-1 to keep interest rates on hold this month, according to the minutes of its meeting released yesterday, with Sushil Wadhwani the only member favouring another cut in borrowing costs.

The minutes revealed that the Bank is worried that another cut in rates could add imbalance in the economy between strong consumer demand and weak domestic growth.

"Policy action to offset these effects would, however, tend further to stimulate consumption and so to worsen the imbalances. These could then prove more problematic for the control of inflation in the medium term. That was a key policy dilemma," the minutes said.

The committee has cut rates three times since February to insulate the economy from the global slowdown, but it now fears households have simply spent the savings on their mortgage bills, adding to the strength of consumer demand.

Economists had expected at least one more cut in interest rates this year, but news of a surge in inflation last month has now led many to predict the next move in rates will be upwards.

"Instead of staying below target, as the MPC expected, it's quite possible inflation will now be back at target later this year," said Michael Taylor, economist at Merrill Lynch, arguing that the next move in rates was likely to be higher.

The committee's dilemma was highlighted by new figures showing the trade gap hit record levels in the three months to April, while mortgage borrowing was at its highest in six months.

Manufacturers' pain in the face of strong sterling and weak world demand is deepening, with Britain importing £2.8bn-worth more in goods than it exported in April, according to official figures.

"It's not a good time to be producing or exporting," said Ross Walker, of Royal Bank of Scotland.

Hopes that the service sector could escape the global slowdown were dashed, as the trade surplus in services fell to £700m, its lowest level since January 1999, and not strong enough - even combined with increased oil exports - to prevent the global deficit from continuing to grow.

The woes of exporters do not seem to have fed through to British shoppers who are still buying imported goods, particularly cars, while figures from the British Bankers' Association showed an underlying rise in lending to the private sector of £9.48bn in May, the strongest monthly rise since last August.

Industry groups said that, while the Bank was right not to cut rates this month, despite the problems of the manufacturing sector, it should not rule out further reductions.

"At the very least the Bank should keep a further rate cut in reserve should clearer signs emerge over the coming months of worsening economic conditions," said Ian Fletcher, chief economist at the British Chambers of Commerce.

"The message in terms of domestic rates is really rates on hold, probably for the remainder of this year," said John Shepperd, at Dresdner Kleinwort Benson.