Interest rates set to be held, but May hike 'in play' despite falling inflation

Policymakers are expected to keep interest rates on hold at 0.5% on Thursday after inflation fell to a seven-month low, but experts believe a hike may still be on the cards for May.

The rates decision comes after official figures showed inflation falling to 2.7% in February - its lowest level since July last year - as the squeeze on household finances finally begins to ease off.

While inflation cooled more than the Bank of England expected, economists predict the Monetary Policy Committee (MPC) will still be keen to bring rates up to more normal levels after more than 10 years of record low borrowing costs.

Interest rates
Governor Mark Carney has already warned rates will need to rise "somewhat earlier and by a somewhat greater degree" to get inflation back to target. (PA)

Howard Archer, chief economic adviser to the EY ITEM Club, said falling inflation "should make little difference to the monetary policy outlook and we expect this week's meeting to prepare the ground for the MPC to hike rates again in May".

James Smith, an economist at ING, added that improving wage growth may also spur the Bank into action.

Office for National Statistics figures on Wednesday showed that wage growth lifted to 2.8% in the year to January, a rise of 0.1% on the previous month, and the highest since September 2015.

But it still failed to outpace inflation, which was running at 3% in January.

Mr Smith said: "Policymakers are increasingly focusing on wage growth, which has been showing signs of life recently, potentially suggesting firms are increasingly having to lift pay more rapidly in a bid to retain and attract talent.

"This, combined with the latest Brexit progress - which bolsters the Bank's argument that the move to the post-Brexit world will be smooth, makes a May rate hike increasingly likely."

Governor Mark Carney has already warned borrowers that rates will need to rise "somewhat earlier and by a somewhat greater degree" to get inflation back on target after stronger-than-expected growth in the economy.

Experts believe the comments last month paved the way for two rate rises in 2018, and another in 2019, which would see rates climb to 1.25%.

The MPC is expected to raise rates alongside the next set of quarterly inflation forecasts in May, according to economists.

However, this month's meeting comes amid signs that the economy is also struggling to pick up pace.

Official figures showed the economy grew by less than previously thought, up by 0.4% in the final quarter of 2017 against the 0.5% initial estimate.

This means it has remained in line with the 0.4% seen in the previous quarter, while experts are pencilling in 0.4% again in the first quarter of 2018 as construction and manufacturing sectors struggle.

The powerhouse services sector continues to be a bright spot, unexpectedly reaching a four-month high in February, according to the most recent purchasing managers' index.

Chris Williamson, IHS Markit's chief business economist, said the services sector boost keeps a May interest rate hike from the Bank of England "very much in play".

But not all economists are convinced over the rates outlook, with Samuel Tombs at Pantheon Macroeconomics saying the latest inflation figures "give the MPC reason to doubt the case for raising interest rates again as soon as May".

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