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PREVIEW-Shock UK rate rise not ruled out at Feb meeting
February 7, 2011 / 3:01 PM / 7 years ago

PREVIEW-Shock UK rate rise not ruled out at Feb meeting

What: Bank of England’s February monetary policy decision

When: Thursday Feb 10 at 1200 GMT

BoE seen keeping rates at 0.5 pct; 1 in 5 chance of rise to 0.75 pct

By Christina Fincher

LONDON, Feb 7 (Reuters) - The Bank of England will have to decide this week whether its first priority is to tackle soaring inflation or to support Britain’s fitful economic recovery.

Such opposing risks put Britain’s central bank in an unenviable dilemma and mean Thursday’s decision is the first since rates were cut to record lows in March 2009 when investors have felt in any real doubt about the outcome on rates.

News Britain’s economy contracted at the end of 2010 has encouraged analysts to stick with their view that the BoE will keep interest rates on hold until much later in the year. [ID:nLDE7100Q5] A Reuters poll last week showed only 21 out of 67 analysts thought rates would go up before the fourth quarter.

However, with pipeline price pressures building and the BoE’s credibility under threat, money markets ICAPSONIA are pricing in around a 20 percent chance of a quarter point rise to 0.75 percent this week, and a 100 percent chance of such a move by May.

The contrast between analysts’ views and Sterling Overnight Interbank Average Rates may partly reflect overshooting by the market. After many months when investors saw little need to hedge against a rise in interest rates, they have been piling into the market to do so, distorting prices. [ID:nLDE712198]

UK interest rates have stood at 0.5 percent since March 2009, when the BoE slammed monetary easing onto full throttle to protect the economy from the ravages of recession and deflation.

Fast-forward two years and Britain’s problem is with prices rising rather than falling. Inflation hit an eight-month high of 3.7 percent in December, almost twice the central bank’s target, and looks set to rise even higher in the coming months.

“We expect the Monetary Policy Committee will leave rates on hold at the upcoming meeting but it may be a much closer call than many expect,” said Michael Saunders, UK economist at Citi.

“We expect that inflation will stay above target for an extended period, not just this year but probably 2012 and 2013 as well.”

CREDIBILITY AT STAKE

A rise in interest rates might reassure investors that the central bank was serious about bringing inflation back to target -- something they have started to doubt after three years of persistent overshoots.

BoE policymakers will have updated inflation and growth forecasts this week that are likely to show consumer price inflation approaching 5 percent in the coming months.

The doves on the BoE’s monetary policy committee might take comfort from the fact that domestically-generated inflation remains benign. Although public inflation expectations have risen, wage inflation remains subdued by historical standards, running at a year-on-year rate of 2.1 percent in the three months to November.

The hawks, led by Andrew Sentance and Martin Weale -- two members who voted for a rate rise in January -- will argue that pre-emptive action is needed: by the time second-round inflation effects are felt, it is too late to put the inflation genie back in the bottle.

In an interview last week, BoE Deputy Governor Charles Bean said that if oil prices surged and inflation became embedded, then interest rates would have to rise even if growth was weak. [ID:nLDE7122DY]

With the outlook so murky, BoE policymakers might decide to keep policy unchanged this month but send a message, spelt out in next week’s Inflation Report, that rate rises might not be far away. That would avert a shock move this month and pave the way for a rise in March or April.

“There is now major uncertainty over interest rate prospects in both the very near term and further out,” said Howard Archer at IHS Global Insight.

“Further increases in headline inflation over the coming months and rising inflation expectations could well force the Bank of England’s hand sooner rather than later.”

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