Holding pattern

Tomorrow, the Bank of England is likely to disappoint those who have been clamouring for a cut in interest rates. Barring a major surprise, the nine members on the Bank's monetary policy committee will leave rates at 4.5% for the sixth month running.

The British Retail Consortium yesterday said sales were only 0.2% higher last month than in January 2005, once increases in floor space were taken into account.

Retailers have said that consumer spending turned soft again after a brief Christmas flurry and they would like the Bank to ride to the rescue. That is not going to happen, not just yet anyway.

After repeated warnings last year about the dangers of overspending and rising indebtedness - Britons now owe a total of £1 trillion - the Bank is probably comfortable with the fact that consumers have curbed their enthusiasm for shopping.

The inflation hawks on the committee will also have noted the renewed strength of the housing market at the start of the year, significant increases in gas prices and the rising cost of raw materials to manufacturers.

In recent meetings, MPC members have also stressed the importance of pay settlements at the start of January. They are concerned at the prospect of employees pushing for higher pay claims to compensate for a bigger tax burden, increased utility and council tax bills, as well as still high petrol prices.

"The MPC still has to see conclusive sustained evidence that 2006 pay settlements are remaining contained," said Howard Archer, an analyst with Global Insight.

For the time being, those favouring a steady-as-she goes policy are in the ascendancy. In the past two meetings, Stephen Nickell was the only member to vote for a cut of 25 basis points. It is difficult to see that 8-1 majority overturned tomorrow in the absence of data showing a dramatic weakening in the economy.

According to Bank minutes, Mr Nickell argued that economic growth had been below trend for some time. He pointed out that a softer labour market and weak industry surveys indicated an output gap - the difference between demand and potential supply. That in turn could push inflation below the Bank's 2% target.

Figures released today on the industrial sector will supply ammunition for Mr Nickell. According to the Office for National Statistics, manufacturing output rose more than expected in December but last year, overall, was the worst for the sector since 2002.

For some economists, the persistent weakness of the UK manufacturing sector in the face of a global industrial recovery raises questions about the ability of exports and industry to pick up the baton at a time when consumer demand is soft.

"If UK GDP has really been below trend for five of the past six quarters, as the official data suggests, then perhaps there is more spare capacity in the UK than the MPC currently assumes," said John Butler, an analyst with HSBC.

Mr Butler said the dilemma facing the MPC was whether to respond to the growing doubts over the extent of economic recovery this year or feel constrained by the rebound in the housing market.

If the bounce in house prices proves to be transitory - and the chances are that it is because of affordability constraints, high debt levels and moderate earnings growth - the Bank will have more latitude on rates.

Amid signs of weakness not just in consumer demand but also in manufacturing, the chances are that the MPC will cut rates some time this year, but not tomorrow.