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MPC fears upcoming austerity measures and Euro crisis

The Monetary Policy Committee unanimously decided to hold interest rates at 0.5 per cent this month but is concerned about the immediate future of the UK economy.

In its latest minutes, the Committee revealed all the members were agreed in keeping the base rate at 0.5 per cent and were confident that inflation would fall back to 2 per cent by 2011.

But the report warned that the crisis on the Continent, along with the upcoming emergency Budget by the new coalition Government may dampen any economic growth through to next year.

The report says: “The pace of that recovery would be dampened by several factors: the need for a substantial fiscal tightening at home and abroad; needed further strengthening in the balance sheet of the UK banking sector; and the private sector’s desire for higher savings in an environment of increased uncertainty.”

But the report does suggest the recent £200bn quantitative easing stimulus might be working – the supply of money increased by 6 per cent in the last quarter, a clue to suggest more of the stimulus might be trickling into the real economy from institutional investors.

The report says: “The latest indicators suggested that the availability of credit had continued to ease gradually, although conditions remained tight.”

While inflation rose to near two-year highs this week of 3.7 per cent, the MPC says it remains confident that this increase will stop and will allow the Committee to hold off on rate increases until 2011.

Henderson chief economist Simon Ward says the Bank of England governor Mervyn King’s explanation of increased inflation due to rising oil prices, falling Sterling and the December VAT increase is “dubious”.

He says: “The central projection in the May 2009 Inflation Report was for inflation to fall to 0.7 per cent by the second quarter of this year. This incorporated the planned VAT rise and was based on a similar effective exchange rate level to today. Higher energy prices can account for only about 0.5 of a percentage point of the 3 per cent forecast miss.

“The Bank’s error was to place too much weight on the output gap as a driver of inflation while underestimating the impact of Sterling’s decline to significantly undervalued levels.”


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