Bank of England keeps rates on hold

The Bank of England kept interest rates pegged at 4.75% yesterday for the fifth month running as evidence emerged that the country's long-suffering manufacturing sector is heading back into recession.

Separately, the European Central Bank (ECB) held rates at 2% for the 19th month in a row and hinted that it would hold them there for most of this year because of slow growth in Germany and France.

The decision by the Bank of England's monetary policy committee was widely expected in the City and will be a relief to homeowners who are already facing the possibility of a falling housing market this year.

But the pound fell back towards $1.88 on the foreign exchanges as traders started to consider that interest rates might be cut at some point this year, particularly if house prices weaken. Roger Bootle, a leading economist, even speculated that a rate cut could come as soon as next month.

Figures from the Office for National Statistics showed manufacturing output suffered another unexpected fall in November, meaning that production has dropped in five of the past six months for which there are figures.

Unless there is a sharp rebound in December - which is highly unlikely, the ONS said - manufacturing will show an overall decline in the fourth quarter of the year, as it did in the third. That would meet the technical definition of a recession.

The ONS also said that manufacturing output for 2004 would be only about 1% higher than the year before, a disappointing performance in a year when the world economy grew at its fastest pace for three decades.

Manufacturing output fell 0.1% in November, matching October's fall and defying City forecasts of a healthy bounce.

Manufacturing has been declining for years, hit by intense competition from countries such as China, the strong pound of recent years and sluggish global demand prior to last year. The sector has shed 750,000 jobs since Labour came to power in 1997.

Simon Rubinsohn, an economist at Gerrard, said the sector was back in recession, having only enjoyed a modest recovery earlier this year.

"This casts some doubt on hopes for the corporate sector to take on a greater responsibility in driving UK growth as households move to the sidelines. We suspect that any rebound in manufacturing output in 2005 will be of very modest proportions," said Mr Rubinsohn.

The weakness of manufacturing output, which accounts for just under a fifth of the economy, is also dragging down overall growth. The economy probably only grew by 0.4% in the fourth quarter as a result, according to data from the National Institute of Economic and Social Research - considerably slower than the economy's usual growth rate.

The NIESR said it saw no need for interest rates to be cut at the moment. But Mr Bootle and some other economists say that growing evidence of housing market weakness and a fairly tough Christmas for retailers mean it is only a matter of time until the Bank cuts the cost of borrowing.

In Frankfurt, the ECB chief, Jean-Claude Trichet, signalled a significant softening of the central bank's previously hawkish outlook on inflation and, by implication, interest rates. He indicated that inflation would fall below its 2% target later this year after sticking at a higher level "over the coming months".

But Mr Trichet reiterated the ECB's concern that, over the medium term, "the combination of high excess liquidity and strong credit growth could in some countries become a source of unsustainable price increases in property markets" and called for close monitoring of "upside risks to price stability over the medium term".

Most analysts expect the first rate rise at the end of the year, although some see them staying at 2% well into 2006.