BoE set to keep rates at record low -- for now

By Christina Fincher

LONDON (Reuters) - The Bank of England looks set to keep interest rates at a record low of 0.5 percent on Thursday, judging that Britain's recovery is currently too fragile to sustain a spiral of rising prices.

It is not a foregone conclusion, however. Some policymakers are growing increasingly nervous about the threat of inflation, and the European Central Bank gave a strong hint last week that it would raise rates next month.

Three of Britain's nine-strong Monetary Policy Committee voted to raise interest rates in February, so it would only take two to switch camps to get a majority.

However, there are strong arguments for not raising rates just yet. Not only is Britain's economy more fragile than many of its peers, it also faces deep public spending cuts, the bulk of which have yet to kick in.

While the country's manufacturing sector is enjoying a strong rebound -- data earlier on Thursday showed the biggest rise in factory output in 10 months [ID:nAHL8EE7E3] -- the dominant services sector is struggling.

Most investors believe the BoE will want to see how the economy fared in the first quarter of this year before acting, meaning a rise is not likely until May at the earliest.

"Although we believe the ECB's announcement puts a little more pressure on the MPC to tighten, we think a tightening this month is unlikely," said Simon Hayes at Barclays Capital.

"There is some residual question mark over the robustness of the recovery and the ability of the economy to withstand higher interest rates."


Markets are pricing in little more than a 10 percent probability of a rate rise this session, so an increase would be a major shock.

Only one of 63 economists polled by Reuters last week expects a UK rate rise this week and many don't expect any rise until the third quarter of the year.

"Headline inflation is high, but domestically generated inflation is low," said Melanie Baker, an economist at Morgan Stanley.

Unless there is a marked pick-up wage inflation or an acceleration in economic activity, Morgan Stanley economists do not expect the BoE to raise rates until August.

Britain's economy lurched into reverse with a shock 0.6 percent contraction in the final quarter of last year.

The Bank of England may also be wary of rocking the boat less than two weeks before the government's March 23 Budget.

Britain's coalition government announced a drastic four-year fiscal tightening program last year but a good deal of the pain will not be felt until the new fiscal year starts in April.

Since it was made independent in 1997, the BoE has only ever made one monetary policy change in the month of March and that was two years ago, when it slashed rates to 0.5 percent and launched its unprecedented quantitative easing program.

(Editing by Patrick Graham)