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BoE Holds Rates Despite Stalling UK Economy

The Bank of England held interest rates steady at 5 percent Thursday, as widely expected, despite growing evidence that the UK economy is close to slipping into recession.

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With inflation more than double the central bank's 2 percent target, all 67 economists polled by Reuters had expected the Monetary Policy Committee to keep rates unchanged.

Still, interest rate futures slipped as some investors had priced in the outside chance of a cut due to the speed and scale of Britain's economic slowdown.

Money markets are pricing in a good chance of three quarter-percentage point cuts by this time next year.

"We continue to see rates being cut -- but not until next year when the inflation peak should have passed," said George Buckley, chief UK economist at Deutsche Bank.

Economic news in recent weeks has been unremittingly grim. House prices are tumbling, unemployment is rising and consumer confidence is at rock-bottom.

Figures out just before the BoE decision showed house prices fell a record 12.7 percent on the year in August, according to Britain's biggest mortgage lender HBOS.

New car registrations also fell 18.6 percent on the year in August to the weakest number of sales since 1966.

Conflicting Views

The BoE's nine-member Monetary Policy Committee was split three ways last month. Tim Besley wanted to raise rates to make sure high inflation did not spread through the economy.

But David Blanchflower wanted to cut rates to ease the economic pain and has since signalled that he might have voted for a half-point cut in borrowing costs this month.

The remaining seven, including Governor Mervyn King, thought no change was the best option due to the competing risks and a similar analysis is expected to have taken place at this month's meeting.

Some economists believe a rate cut could come as early as November as inflation may have peaked by then, particularly if oil prices continue to fall.

(Watch the video above for instant analysis of the BoE decision.)

Crude oil prices hit a five-month low below $106 a barrel this week, having fallen more than $40 from July's all-time peak.

However, more hawkish members of the MPC may still be concerned that the high inflation will feed into high wage demands, and may want to wait for the January pay round.

By making imports more expensive, sterling's sharp fall on the foreign exchanges has also added to inflation risks.

The pound has suffered its worst month against the dollar since its ejection from Europe's Exchange Rate Mechanism in 1992 and shows no sign of recovering.

Lastly, there is the risk of tax cuts and spending increases in the government's autumn pre-Budget Report.

If the government wants to deliver a fiscal stimulus, the central bank may be more reluctant to deliver a monetary one.

"All good things come to an end, and, unfortunately, UK growth is no exception. After the economy broke its astonishing winning streak of 15 years of continuous growth this summer, the next UK rate move will almost certainly be down," said Stuart Porteous, head of RBS group economics.

"But not just yet. The MPC looks set to keep rates on hold until it is unambiguously clear that inflation has passed its peak -- and that probably won't happen until early in 2009," he said.

- Reuters contributed to this report.