'Interest rates set to stay at 0.5% well into next year'

With interest rates effectively as low as they can go, the Bank of England is putting its hopes in the creation of new money

INTEREST rates look set to remain on hold for the rest of the year as the Bank of England focuses its efforts on boosting the flow of cash to drag the economy out of recession.

Economists said the central bank's early efforts with quantitative easing (QE) – in which it buys up corporate bonds and government gilts – had met with mixed results.

The Bank's monetary policy committee (MPC) yesterday held its base rate at the historic low of 0.5 per cent and confirmed it would continue the first stage of its £150 billion QE programme.

The decision to freeze borrowing costs, a move that had been widely predicted, came after six months of cuts, which had taken interest rates down to their lowest level in history.

About £26.5bn has been spent in the past month under the liquidity scheme's first tranche of £75bn, with the MPC hoping the cash paid for the bonds will be passed on to businesses in the shape of increased lending.

Tentative signs of more cash being lent by banks have been noted in some quarters, but investors in the gilt markets appear concerned about short-term deflation and then long-term inflation. The MPC did not alter the scope of its QE yesterday as rate-setters wait to judge the effect of their efforts.

Liz Cameron, chief executive of the Scottish Chambers of Commerce, said: "We may in recent weeks have begun to see some embryonic evidence of a more open attitude from the banks on business lending and it is hoped that actions taken by the UK government over the past six months may be beginning to bear fruit at long last."

Commenting on the progress of QE, Edward Menashy, chief economist at Charles Stanley, said: "Anecdotal evidence suggests that £20bn of gilts have been bought, leaving the Bank of England well on target to meet its initial objective of £75bn.

"However it has had more of a struggle in buying corporate bonds, with purchases to date amounting to less than £400 million."

Howard Archer, chief economist at IHS Global Insight, added: "QE is clearly now at the forefront of the Bank of England's attempts to stimulate economic recovery, not only because the bank rate has fallen as low as it can effectively go, but also because the lack of availability of credit is a serious threat to recovery prospects.

"We suspect interest rates are set to stay at 0.5 per cent well into 2010 and also believe the quantitative easing programme is likely to be extended."

The decision to hold rates and keep the pace of QE unchanged reflects the difficulty of judging the impact of the measures just a month into the process – although Bank of England Governor Mervyn King told MPs two weeks ago that he was "mildly encouraged" by results so far.

The bank's latest credit conditions survey showed lenders indicating they would make more credit available to individuals and businesses in the coming three months.

Stuart Porteous, head of economics at Royal Bank of Scotland, said: "Any talk of recovery is premature. The Bank of England has emptied both its barrels, and it will be some months before we can judge just how successful it has been."