Bank of England set to hold rates

The Bank of England looks set to hold off from cutting interest rates on Thursday as policymakers' worries about higher inflation trump their fears of a sharp economic slowdown.

Money markets show no realistic chance of a rate cut at 12 p.m., despite mounting evidence the economy is reeling from the credit crunch and the housing market could be in for a hard landing.

A survey on Wednesday showed the services sector contracted last month for the first time in five years while employment in the sector suffered its sharpest decline in more than a decade.

"Over the past ten years weak PMI data would normally be followed by a rate cut as the MPC sought to ease pressures on the economy," said Ian Kernohan, an economist at Royal London Asset Management.

"Times have now changed and the MPC actually wants the economy to slowdown quite a lot in order to contain stubbornly high inflation."

Only 2 out of 71 analysts polled by Reuters last week expected the central bank's Monetary Policy Committee to chop borrowing costs this month. The rest predicted rates would stay at 5.0 percent for a second month running, and probably for a while longer.

That's a far cry from a few weeks ago when a majority were gunning for rapid rate reductions.

April's inflation number was the shocker for both analysts and policymakers, showing a jump in the annual rate to 3.0 percent, a full percentage point above the central bank's target.

The Bank would find it hard to cut rates when its mandate is to keep inflation at 2 percent.

Some traders are even betting interest rates could rise by the end of the year. But policymakers have given little indication that they are even beginning to consider this while the economy is vulnerable.

In its inflation report last month, the Bank indicated it expects inflation eventually to ease, potentially allowing it to cut rates if the economy continues to weaken.

"Unlike the market we see very little change of rate hikes," said Michael Hume at Lehman Brothers.

"We remain comfortable with our call for the Monetary Policy Committee to cut rates by 25 basis points at its August meeting."

Bank Governor Mervyn King will get the chance to set out the bank's latest thinking when he makes a major policy speech next Tuesday.