--- by Pan Pylas ---
LONDON (AFX) - The Bank of England's decision to hold rates may not have been a surprise to the market but it has reinforced the view that UK borrowing costs have reached their trough at 4 pct, economists said.
Next week's Inflation Report will provide some explanation into the rate-setting Monetary Policy Committee's reasoning but there seems to be little doubt that the economy's current imbalances are providing increasing cause for concern.
While official data earlier today showed the manufacturing sector mired in its worst recession since the summer of 1991 and the continued risks in the global economy, consumption in the UK remains particularly buoyant. Only yesterday the Halifax said house prices are rising at their fastest rate since 1989.
"What concerns the MPC is that by cutting rates aggressively, they have spawned a consumer monster," said Deutsche Bank economist Ciaran Barr, who has raised his official repo rate forecast from a trough of 3.5 pct to 4 pct.
David Page, economist at Investec, agrees that rates have probably bottomed at 4 pct and that the BoE will avoid exacerbating the economy's imbalances at the expense of a central RPIX inflation projection below target over the forecast horizon. The MPC, Page noted, discussed exactly this at January's meeting. "It might be necessary to accept inflation remaining a little below target over the two-year horizon," the MPC said. Economists were keen to stress that fears of a sudden move towards tighter policy are overdone, but Mike Taylor, economist at Merrill Lynch warned that rates may have to rise "sooner rather than later" if the consumer side stays strong and the global economy shows robust signs of recovery.
Deutsche Bank's Barr expects interest rates to peak this year at 4.5 pct, with the first 25 basis point rise in the third quarter. "While reports of the consumer's demise have time and time again been exaggerated, the current strength is unlikely to be sustained at this pace," he said.
Moreover, he said the economy has benefited from consumer buoyancy at a time when little else has been able to keep it afloat. "This (and uncertainties over the global economy) point to 'wait-and-see' from the MPC since they do have that luxury," he said. "Even with a consumer surge, inflationary indicators are, as noted, muted and this is far from a sterling-related phenomenon." Investec's Page also thinks that consumption growth should slow over the coming quarters but does not expect a dramatic retrenchment. "We therefore expect rates to remain on hold in the UK until there is a sustained recovery in the manufacturing sector, which we not expect to be visible until the second quarter," he said.