The economy is going backwards, not forwards

The City is predicting that the Bank of England's monetary policy committee will leave interest rates on hold when it announces the determination of its monthly meeting today.

A couple of months ago the betting was that the MPC might have been tempted to push through another rate rise. However, putting up borrowing costs so soon after the election might have been seen as the committee's verdict on a third Labour term - something the Bank's governor, Mervyn King, who had delayed the MPC meeting to avoid a clash with the election, was keen to avoid.

But in anticipating the MPC decision to leave rates unchanged at 4.75%, the City is focusing firmly on economic factors.

Between November 2003 and August last year the MPC raised interest rates five times to rein in consumer spending and cool an overheating housing market.

Since then there have been increasing signs that its monetary medicine is working well, perhaps too well. Consumer spending growth has slowed sharply, house prices have not budged since last autumn, and car sales have decelerated.

Added to that, the poor old manufacturing sector looks to be heading back into the doldrums.

Against that is a strong labour market, robust average earnings growth and a pick-up in inflation to a near seven-year high of 1.9%, caused partly by high oil prices and rising airfares.

The reason many thought the Bank would raise rates again this month is because the MPC meeting coincides with the analysis that the Bank commissions for its quarterly inflation report, which it will release on Wednesday.

History shows the committee is twice as likely to change rates in an inflation report month than in the intervening period.

The unexpected rise in inflation in March will alter the starting point for the Bank's projection of inflation over the next two years, the time it judges for its rate changes to have their full effect on the economy.

If it judges that inflation will be materially above its government-set target of 2% in 2007, it may be tempted to increase rates again to prevent that happening.

Indeed, two of the nine members - Paul Tucker and Sir Andrew Large - voted in the past two months for an immediate rate rise, but the others were unconvinced, especially as the signs of weak consumption were coming through.

The committee has identified the possibility of a sharp slowdown in consumer spending as a key downside risk to its inflation forecast.

And, judging from the howls of complaints from just about all the country's retailers, that downside risk looks as if it may be materialising.

A new report out today suggests that while consumers are becoming slightly more optimistic about their own finances and house prices, they would rather save money this year than spend it.

The forecasting group Experian Business Strategies said: "People are more cautious about taking on further credit and a cooler housing market is depressing sales of household goods. We expect slower consumer spending growth and retailers of durable goods in particular will face a harder year in 2005."

The tighter times for consumers' pockets were reflected in data last Friday that showed personal insolvencies hit a record high in the first quarter and were up 25% in just a year.

Figures from the British Retail Consortium due this week will provide further evidence of the consumer slowdown. They are reported to show a like-for-like fall of 1.5% last month compared with April 2004.

Things could get a lot worse if the housing market turns down again.

Although prices have largely been stable so far this year, some economists think this is typical of the early phase of a housing market bust as buyers drop away but sellers refuse to cut their price to shift a property.

At some point, though, sellers could well decide they cannot expect to get the price they were hoping for and could go in pursuit of buyers.

A psychological trigger for this could come in the late summer when the annual rate of house price inflation - currently running at 7%-8% a year - falls to zero, as it almost certainly will.

That's a crucial reason why many in the City think interest rates could be on their way down again by the end of the year.