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The economy staged a somewhat muted rebound in the first quarter of 2011, recovering the ground lost during the snow-affected Q4 but failing to build upon it.

Consequently, the Bank of England looks set to leave interest rates on hold at 0.5% next month.

The economy recovered all of its fall in Q4, but that leaves the level of economic activity unchanged on last autumn and still 4% below its peak three years ago.

This is not a disastrous outcome – recoveries are often bumpy in their early stages – but it will induce caution on the part of Bank of England interest rate setters.

A rate hike at the May MPC meeting, in the context of the Bank’s latest quarterly forecasts, looks distinctly unlikely.

As in politics, voting within the 9-member MPC is often all about the middle-ground.

For the ‘swing voters’ the main hurdle to higher interest rates appears to be the shaky growth numbers.

The inflation data have been sufficiently sticky and uncomfortable for policymakers.

But with the squeeze on household incomes now more in evidence clearer signs of a pick-up in activity probably need to emerge in order to persuade a majority of the Committee to back higher rates.

Whilst it is possible that the economy gains some traction later in the year, the terrain looks challenging.

The probable reduction in working days in Q2 as a result of extended holidays around Easter/Bank Holidays/Royal Wedding is likely to outweigh any boost to the economy from sectors such as retail or tourism.

"The Bank of England looks set to leave interest rates on hold at 0.5% next month."

Ross Walker

Consequently, whilst we expect ongoing expansion, the pace of economic growth will probably remain constrained.

As we head into the second half of the year the step-up in fiscal tightening will dampen public sector output and household income growth remains anaemic - we expect another fall in real household disposable income this year.

For the Bank of England, no change in rates in May would not preclude a rise later in the year.

The debate is likely to remain delicately poised and we expect this to be reflected in the MPC’s next set of projections, in the May Inflation Report, for CPI inflation to be close to the 2% target at the 2-year forecast horizon.

A further point to note on the BoE is that May is the final meeting for the MPC’s leading hawk Andrew Sentance.

His replacement, Ben Broadbent, is reckoned to have hawkish leanings but the working assumption at this point has to be that there will be some dilution in the Committee’s predilection to raise rates.

The big picture in the UK remains much the same.

Economic growth has resumed, but at a somewhat lacklustre pace and with various headwinds likely to pick-up.

Households can be forgiven for not noticing much of a recovery – real disposable income fell last year and we expect more of the same this year (in part a reflection of the pain inflicted by ‘high’ inflation).

With fiscal austerity being stepped up this year, interest rates will remain at low levels – but probably slightly above where they are at present.

We forecast one 25 basis point rise this year (to 0.75%) with just two quarter-point rises (to 1.25%) in 2012.

UK Economy News