Last updated at 1:00 PM on 13th January 2011
Interest rates were kept at 0.5% today despite the threat of high inflation and rising commodity prices.
The Bank of England's monetary policy committee decided against a rise to combat inflation, which is way above target - the consumer prices index (CPI) came in at 3.3% for November, after remaining at or above 3% for the whole of 2010.
That is more than 1% above the Bank's 2% target rate, but the MPC has remained firm in its view that the real economy needs rates to stay as low as possible and that inflation will fall back over the long term.
Frozen: Rates have been kept at a record low for nearly two years
But with inflation set to stay above 2% for most of this year, the credibility of the MPC is on the line.
VAT and fuel increases at New Year plus higher import prices resulting from the fall in the value of the pound can only add to inflationary pressure - CPI could hit 4% by spring, some believe.
Many think this could force the MPC into a rate rise soon. Last month, the CBI warned that rates would start to rise by the spring and the base rate would hit 2.75% by the final quarter of 2012.
But most economists and the markets are not expecting a hike until the last quarter of this year or the first quarter of next.
According to Nida Ali, economic advisor to the Ernst & Young ITEM Club, the MPC's thinking is sound, because 'underlying price pressures remain low'.
'Indeed CPIY (inflation excluding indirect taxes) was depressed at 1.6% in November,' she said. 'We are of the view that the MPC should only respond with monetary tightening in the event that high inflation begins to become entrenched in people's expectations reflected by unsustainable increases in wage settlements.
'An increase in interest rates right now will be premature and is likely to dampen an already fragile economy. The Bank should hold its nerve in what looks like a difficult year ahead.'
Adding to the MPC's problems has been an inability to get a unanimous agreement on the best way forward.
At every monthly meeting since October, the MPC has been split three ways, with votes for both tighter and looser monetary policy and for no change, this last position having carried the day.
Andrew Sentance has repeatedly called for gradual interest rate rises to stave off the rising threat of inflation. But the consensus of the committee is that most of the inflationary pressures should fall away in a year's time, with Adam Posen arguing for more stimulus.
'It would be sensible if we can get rid of this three-way split,' said Peter Dixon, strategist at Commerzbank. These mixed messages are undermining the MPC's position.'
There was good news on the economy today, with manufacturing output growing slightly faster than forecast, helped by strong growth in car production and food processing.
The 0.6% monthly rise matched October growth that was the strongest since March.
But there remain concerns over the strength of the recovery, which weakened in December, hindered by the Arctic weather.
Markit/CIPS data showed that the construction sector fell further into decline in the month, while the powerhouse services sector contracted marginally for the first time in 20 months, leaving only the manufacturing sector in growth.
GDP figures for the second and third quarters were also revised down from 1.2% to 1.1% and from 0.8% to 0.7% respectively.
Markit economists said the recovery had 'near-stagnated' and expect the UK's GDP growth in the fourth quarter of 2010 to be just 0.4%.
British Retail Consortium figures released earlier this week showed sales in December were at their worst for eight months as the snowy weather and money worries caused shoppers to cut back on buying presents.
The resilience of the real economy, as well as above-target inflation, appears to have extinguished the chances of more quantitative easing. The Bank has printed 200bn and spent it on buying financial securities to pump money into the system.
It really is quite pathetic.I remember reading that just as interest rates fell quickly,they can rise just as quickly.The Bank of England are unpopular because of their constant dithering.There are far too many doves as opposed to hawks and if people that have loans now can hardly afford their repayments on artificially low rates,then they are not going to know what has hit them when rates do begin to rise and rise they will just as night follows day.
- Lesley, Northumberland, 13/1/2011 18:39
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