Uncertain upturn prompts Bank to put rates on hold

Worries about the real strength of Britain's economic recovery yesterday prompted the Bank of England to keep interest rates at a 38-year low of 4% for the sixth month in a row.

Industry leaders greeted the decision by the nine-strong monetary policy committee with relief, warning that manufacturing was still too weak to withstand the rise in borrowing costs that many City analysts believe will be necessary to cool down the booming housing market.

"We welcome today's unchanged interest rates, especially as the jury seems to be out on the strength of the upturn in the economy," said Ruth Lea, head of policy at the Institute of Directors.

Ian Mccafferty, the CBI's chief economic adviser, said: "This was the right decision. The recovery is still at a very early stage and is by no means assured."

The Bank cut interest rates seven times last year to insulate Britain from the global downturn that dragged the economy to a virtual standstill in the final quarter of 2001. Output rose by a feeble 0.1% in the first three months of 2002, weighed down by the slump in manufacturing.

While recent business surveys have suggested that industry has turned the corner, the mood of growing optimism was punctured earlier this week when official figures showed that manufacturing output suffered a sharp fall in March.

Several MPC members, including the Bank's governor, Sir Eddie George, have signalled that despite the sharp rise in house prices, they are in no hurry to raise interest rates until concrete signs of recovery emerge.

The MPC has room to wait and see thanks to subdued inflationary pressures. Underlying inflation stands at 2.3%, just below the 2.5% target the government has set for the Bank.

But the reduction in mortgage costs to their lowest level in 40 years has triggered a renewed surge in house prices, prompting concerns that the property market may be about to retrace the boom and bust cycle of the late 1980s.

Rising house price inflation and robust consumer spending are expected to force the MPC to start raising interest rates in the third quarter, with economists predicting they will hit 4.5% by the end of the year.

"The strength of housing, personal borrowing and car sales testify that the current policy stance is very loose and that consumers are in no way deterred by the rise in household debt levels," said Michael Saunders, UK economist at Citigroup. "We look for the first rate hike to come in either June or July, with rates then rising fairly rapidly as evidence of the recovery's strength continues to come through."

Evidence that booming sales may be pushing up prices on the high street emerged yesterday when the British Retail Consortium reported the fastest increase last month in its index of shop prices since it began monitoring them five years ago.

The BRC said the increase was mainly in the price of convenience food and urged the Bank not to overreact.

"The current levels of consumer confidence should not give the Bank of England cause for concern as competition and efficiency in the retail sector continue to keep high street inflation way below any rises consumers are experiencing elsewhere," said the BRC's director, Bill Moyes.