The Bank of England kept rates steady at 0.5% today, as expected, despite strong inflation pressures.

From Bloomberg: Bank of England Maintains Aid as Inflation Accelerates

The bank may hold fire until later this year, when it will have official data showing the extent of the economy's rebound from a fourth-quarter contraction. Former policy makers DeAnne Julius and Kate Barker said the bank's stance has damaged its credibility and investors have increased bets that officials will raise the rate by June to stem inflation.

The weakness of the fourth quarter was probably temporary and for the bank it's a question of when to raise rates, not if, said Alan Clarke, an economist at BNP Paribas in London. We're at a super-emergency level of rates and the emergency has gone away. We're forecasting the first increase in August but there are risks it could come sooner.

There is no  statement when the BOE holds rates steady so we don't have an insight just yet into what the thinking is after a month of data in which the UK economy looks mixed. However over the next two weeks we'll have a chance to find out what the Monetary Policy Committe is thinking. Next Wednesday we get the banks' INflation Report, which will update its forecasts on inflation and growth, and will give teh MPC a good opportunity to signal what it intends to do with monetary policy.

In two weeks we get the Minutes from today's meeting and we will have the chance to see if another MPC member voted for a rate increase.

In January, Andrew Sentance's lonely vigil as the sole proponent of a rise in rates came to an end, when fellow MPC member Martin Weale also advocated an increase, to 0.75%. Based on his recent comments, BOE Deputy Governor Charlie Bean is seen as the most likely new recruit.

The pressure is building on the BOE to counter-act an inflation rate that was running at 3.7% in December, and may move above the 4% mark in the coming months. However, with an uneven recovery, the bank does not want to add extra strain on consumers and businesses by increasing borrowing costs. The other MPC members believe that the spike in inflation is temporary - pushed up by rising energy and commodity prices and a higher sales tax - and will return back to target next year.

 

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As we can see above in a graph of annual CPI, we have been running above the 3% level for almost all of 2010. We have been hearing from the BOE that inflation is temporary for a while now. The BOE could have tried to flex its muscles with a surprise rate hike to cement its credibility, but that may have been another shock to the UK economy at a time when uncertainty reigns.

In today's trading the GBP/USD has responded by declining, as we had risk-off trading amidst some drops in global equities.  But with substantial weakness in the Euro, from worries over Portuguese debt, the EUR/GBP moves in favor of the Pound.