Bank split three ways on interest rates path

One Bank of England policymaker wanted to raise interest rates this month and another wanted a cut, but the remaining seven chose to keep them steady as both inflation and economic growth prospects had worsened.

Minutes of the July 9-10 policy meeting published on Wednesday showed hawk Timothy Besley wanted an immediate quarter percentage point increase to 5.25 percent, while dove David Blanchflower argued a rate cut was needed to prevent recession.

This produced the first three-way split on the direction of rates since May 2006. Policymakers said the decision was "a difficult one" as inflation was likely to turn out higher and growth lower than the Bank had forecast in May.

Analysts had expected an 8-1 vote for steady rates this month, with Blanchflower wanting a cut. Most argue rates will stay put for now before falling eventually as the economy slows.

A Reuters poll of 70 economists on Wednesday showed a growing risk of recession. Analysts say there is a 40 percent chance of two straight quarters of contraction in the next year, with rates set to fall to 4.25 percent by the end of 2009.

However, sterling rose and bonds fell as the unexpected split Bank vote indicated there was little broad-based support for lower interest rates. If anything, members of the Monetary Policy Committee appeared more inclined to raise rates.

"The minutes are certainly more hawkish than we expected," said Philip Shaw, chief economist at Investec. "The committee gave serious consideration to tightening policy this time round.

"The outlook for interest rates looks more uncertain."

STRONG SIGNAL

The minutes said there was little the Bank could do to tame inflation in the near-term, but also said that a rate rise this month could "send a strong signal that it (Bank of England) was focused on inflation and remained determined to bring it back to target".

Arguing against a hike that would have caught markets hopping, however, policymakers noted significant downside risks to the economy - and hence for inflation in the medium term.

They added that while official second quarter GDP data due on Friday could turn out slightly stronger than expected, survey evidence and reports from the Bank's own agents suggested the economy was continuing to slow.

The Bank's regional agents survey on Wednesday indicated broad weakness across the economy, with property and construction industries among the worst hit, as well as signs that consumer demand was starting to dry up.

"Keeping Bank Rate at 5.0 percent when the economy was slowing was arguably already sending a strong signal of the Monetary Policy Committee's commitment to reducing inflation," the minutes said.

"A rate change this month would be a surprise at a time when credit and other financial markets remained fragile, and any change in rates would be better communicated alongside the Bank's August Inflation Report."

Evidence of a sharply slowing economy continued to roll in on Wednesday, with British banks reporting approvals for home loans tumbled by two thirds in June to a record low, pointing to further sharp falls in house prices in the next few months.

The Confederation of British Industry said optimism in the manufacturing sector was at its worst since 2001, although price pressures were at their strongest in more than 18 years.

"It looks as though stable rates are here to stay for several more months," said James Knightley, an economist at ING.