Bank of England holds interest rates at 0.5%

The Bank of England’s Monetary Policy Committee has held interest rates at 0.5% for a 19th consecutive month in a meeting in which the uncertain economic outlook was expected to have split members three ways.

The nine-strong committee resisted pressure to start up the printing presses again on the Bank’s £200 billion ‘quantitative easing’ programme in which a cash boost is provided to the economy in exchange for government bonds.

The decision to hold rates, made at the end of the MPC's monthly two-day meeting at Threadneedle Street, comes as little surprise as most economists do not expect a rise in the base rate until sometime next year.

One committee member, Adam Posen, last week warned that premature ‘tightening’ – ie, reversing policies such as asset purchases and historically low interest rates – could lead to a Japan-style ‘lost decade’ of lost growth.  

Conversely there are concerns that extending QE would increase already above-target inflation. The committee must balance the need to keep inflation below its 2% target with the threat of a return to recession in the UK, defined as two consecutive quarters of negative growth.

Only one member, Andrew Sentance, has been voting for an increase in interest rates. He cites strengthening economic activity and consistently above target inflation, which will be exacerbated by the January VAT rise. The minutes of the latest MPC meeting will be published on 20 October.

The UK managed economic growth of 1.2% in the second quarter of this year. But since then several economic data releases have painted a mixed picture, with many businesses anxious of the impact of the coalition government’s spending review on 20 October. The International Monetary Fund yesterday downgraded its forecast for global GDP growth in 2011. It has pin-pointed the financial system as the ‘Achilles heel’ of the economic recovery, although in a recent report focused on the UK, the fund was upbeat and said that the economy was on the mend.

Quantitative easing

Several developed nations are now considering further monetary easing. Japan yesterday unexpectedly announced it was dropping its interest rate to ‘virtually zero’ alongside the establishment of a fund to buy government bonds and other assets.

The US is expected to follow suit after Fed chairman Ben Bernanke signalled it may announce the purchase of more Treasuries as soon as their next policy meeting at the beginning of November.

Commenting on today's announcement, Edward Menashy, chief economist of Charles Stanley, said hopes of further QE in the US and UK had been pushing up asset prices: 'So far the effects of QE in stimulating the wider economy have not been impressive.  The bank sector remains weak and unable to increase lending to companies.  There are dangers that further QE could lead to major new problems rather than leading to economic recovery.'

Menashy speculated that the UK's QE programme could be revived in November after the spending cuts have been announced.

The Bank of England's announcement can be seen here.