By Nida Ali, economic advisor to the Ernst & Young ITEM Club
Despite rising concerns about the elevated levels of inflation, an increase in interest rates today would have been very unexpected.
Even without yesterday's subdued figures for manufacturing, there is no conclusive evidence that the recovery remains on track. While the PMI surveys for Q1 have been upbeat, recent months have displayed a wide disparity between these and actual data, and were unlikely to form the basis for tightening policy just yet.
Though there has been some evidence of an increase in inflation expectations, pay settlements have failed to take off. Indeed wage growth according to the latest data was depressed at 2.2% and in the current context of a weak labour market, the possibility of a wage price spiral seems remote.
With growth in manufacturing stagnating in February, and a sharp slowdown in March's corresponding PMI, there are signs that strength in the sector may be faltering. This coupled with ongoing weakness in the service sector makes the case for maintaining a loose monetary policy stance even stronger.
We remain of the view that high inflation is stemming from temporary factors such as the rise in VAT and high commodity and oil prices while underlying price pressures as a result of spare capacity, remain low. Once these temporary factors fall out of the calculation, inflation is likely to come back towards the 2% target in 2012. Interest rates should therefore remain at their current level of 0.5% in the near future.