Bank hints rates will remain unchanged

The Bank of England expects economic growth and inflation to weaken over the rest of the year, in an indication that it will leave rates at their current 38-year low, it emerged today.

In its latest quarterly inflation report, the Bank cautioned that although the world economy has shown signs of revival, the sharp fall in financial markets may dampen recovery at home and abroad.

The Bank noteed that share prices around the world have fallen by around a fifth since its May inflation report, triggered by a sharp fall in the value of US markets because of questions over the "veracity" of reported corporate earnings.

The fall in shares could dampen consumer spending and discourage investment, but the effect may be tempered by the impact of lower market interest rates, the Bank said, adding that overall, the outlook is for continued recovery in world demand, but at a somewhat slower pace than anticipated in May.

"On this occasion, the changes in equity prices have been very large; in fact, the largest change in equity prices in either direction between inflation reports or quarterly bulletins since 1987," said the Bank's deputy governor, Mervyn King. "And this straightforward wealth effect does impact on our judgement for the outlook on consumption."

Despite the plunge in the markets, the inflation report warned of the risk of further falls as "traditional valuation yardsticks such as price earnings ratios remain above their long run historical average."

With inflation at 1.5%, its lowest level on record, the Bank has considerable room for manoeuvre. As it expects consumer spending and the rise in house prices to moderate, the Bank should have little cause for raising rates from their current level of 4%.

Last week, the Bank's monetary policy committee (MPC) left rates unchanged for the ninth month running and the City now thinks they will stay that way for the rest of the year. Most analysts had expected the Bank to raise the costs of borrowing this summer. But so far, only one member on the Bank's monetary policy committee, Mr King has voted - twice - in favour of a pre-emptive strike. The most recent official figures, showing a sharp slump in manufacturing, would also militate against a rise in rates this year.

"The MPC seems to have moved back from a forecast consistent with rising interest rates to one where rates can remain on hold. We expect the MPC to keep rates unchanged for the rest of this year," said Credit Suisse First Boston

Although house prices have continued to surge ahead, the Bank noted tentative signs of a slowdown. With overall consumer borrowing continuing to grow strongly, it said spending was likely to remain firm in the near term, "but slowing growth in real disposable incomes and the recent sharp falls in equity wealth should restrain future spending growth".

The Bank predicts inflation will run below the 2.5% target for most of the next two years before edging up to around 2.5% at the end of the period. This contrasts with the situation in May when the Bank saw inflation rising slightly above target at the end of two years. Gross domestic product growth was likely to return to around its trend rate - 2.5% - over the next year, with the Bank citing downward risks if the recovery took longer to take hold.