BoE holds interest rates, analysts see eventual cut

A sign for the Bank of England is seen in the City of London, February 13, 2008.

LONDON (Reuters) - The Bank of England held interest rates at 5.0 percent on Thursday as policymakers tussle with slower economic growth and surging inflation, but analysts say rates will have to fall eventually.

Markets showed little reaction to the decision, which had been widely expected, and are still betting that interest rates may yet rise this year because of sustained evidence of simmering inflationary pressures.

Inflation is at its highest -- 3.3 percent -- since the BoE won the power to set rates in 1997, making it hard to cut borrowing costs even though the housing market is weakening sharply and surveys point to a shrinking economy.

"We still think the next move will be down," said Vicky Redwood, an economist at Capital Economics. "It might not be for a few months yet, although if the activity data continues to weaken sharply as it has done in recent weeks then we might not have to wait too long."

The latest gloomy reading on the flagging housing market came on Thursday from Britain's biggest mortgage lender Halifax, showing house prices fell at a record annual pace in June. Prices are now nearly 10 percent below the peak hit last August.

Britain's housebuilders say they will have to slash more than 4,000 jobs to help weather the downturn and thousands of estate agents are also expected to find themselves out of work.

Barratt Developments said on Thursday it will cut 1,200, jobs, nearly a fifth of its workforce.

The credit crunch has hit consumers and would-be homebuyers hard as banks react to tougher financial market conditions by tightening up their lending terms. That has driven new home loan approvals down to record lows.

BLEAK SIGNS

Elsewhere, the picture is equally bleak. The closely-watched purchasing managers' surveys are already indicating the economy is shrinking and hopes that a weaker pound would bolster demand for British goods have so far been disappointed.

Despite obvious signs of a cooling economy, some policymakers did consider raising rates at last month's meeting to counter the inflation threat. The BoE has said it would not be surprised to see inflation spike above 4 percent this year.

The European Central Bank raised interest rates last week to tame euro zone inflation and the U.S. Federal Reserve has also been taking a more hawkish stance.

The BoE is charged with keeping inflation at a 2 percent target, not to manage economic growth. But policymakers have also argued that the spike is due to external forces beyond their control, such as soaring global oil and food prices.

There has been little sign so far that inflation pressures are driving wages markedly higher, even though companies have been ramping up their prices to offset higher costs.

The central bank will be hoping that a slowing British economy can help to tame price pressures eventually. But there is a growing risk of recession, and that could drag inflation too low.

By keeping rates on hold this month, the BoE is buying itself a little more time to see what interest rate path is required to bring inflation back to target over the medium term.

In such uncertain times, the minutes to this week's BoE meeting on July 23 could show a split among policymakers.

Arch dove David Blanchflower is unlikely to have dropped his call for lower interest rates but there is also plenty on the inflation front for hawks such as Andrew Sentance and Timothy Besley to argue that rates need to stay on hold for some time.

(Additional reporting by Sumeet Desai, Christina Fincher and Jodie Ginsberg; editing by David Stamp)