Europe risks, U.S. caution weigh on chances of British rate rise

[October 09, 2014]  By William Schomberg

LONDON (Reuters) - The risk of a new recession in the euro zone and caution from the U.S. Federal Reserve are weighing on expectations of the timing of a first increase in British borrowing costs, potentially delaying it.

The Bank of England, as expected, kept interest rates at a record low on Thursday, leaving Bank Rate at 0.5 percent, the level at which it has sat since the worst of the financial crisis five-and-a-half years ago.

Britain's economy has staged a much stronger than expected recovery since mid-2013. But a combination of weak pay growth and inflation below the BoE's 2 percent target has allowed the central bank to keep rates unchanged.

So far only two of the MPC's nine members have voted for a rate hike, but expectations have been strong for hike as soon February next year.

Now British policymakers are casting a nervous eye at the euro zone and in particular Germany, which this week announced a string of far weaker than expected economic data.

Adding to the sense that rate rises might come later than recently thought, the Fed has sounded worried about the impact of the slowdown in Europe as well as in Asia.

In Britain itself, there are some tentative signs of a cooling. The British Chambers of Commerce warned on Thursday of a "first alarm bell" for Britain's rapid economic recovery after firms reported the weakest export growth in almost two years and a big slowdown in manufacturing.

London house prices also fell last month for the first time in more than three years, and prices nationwide showed their smallest increase in 15 months.

If sustained, the slowdown could feed into next year's general election and Conservative Prime Minister David Cameron's bragging rights over an improved economy.

Investors earlier on Thursday showed they were less convinced that the BoE would raise interest rates in early 2015.

Short-dated gilt prices rallied along with other major government bonds and short sterling interest rate futures - <0#FSS:> which are bets on when interest rates will rise - rose strongly.

"We're leaning more and more towards June, and maybe it'll even be after that," said Marc Ostwald, a strategist at ADM Investor Services International, when asked when the BoE might kick off its long-awaited rate hikes.

BLAME EUROPE

The BoE made no statement alongside its monthly policy announcement, which included a commitment to maintain at 375 billion pounds ($607.5 billion) the stockpile of assets which it acquired under its program of government bond purchases.

Minutes of the MPC's meeting are due to be published in just under two weeks' time. The minutes of last month's meeting suggested growing concern at the situation in Europe.

In September, MPC members saw only a modest direct impact of the euro zone's slowdown, but minutes of their meeting showed they felt "a prolonged period of poor growth and very low inflation could have a larger impact if it led once again to uncertainty about the sustainability of euro-area public and external debt".

Indeed British finance minister George Osborne said on Thursday the euro zone risked slipping back into crisis.

Data on Tuesday showed German industrial output in August plunged at its steepest rate since the depths of the financial crisis. The International Monetary Fund has given a nearly 40 percent probability that the currency bloc would enter recession over the next year.

The British economy struggled to grow during 2011 and 2012 when the euro zone was deep in a debt crisis that threatened to break up the single currency area.

Economists say the current growth problems in the single currency area will not deliver as big a hit to Britain. But the European slowdown is a problem for the British manufacturing sector which accounts for about 10 percent of the country's total economy.

Data published earlier this week showed British manufacturing edged up just 0.1 percent between August and July. Surveys have suggested that problems in the euro zone weighed on the sector more heavily in September.

(Additional reporting by Andy Bruce Editing by Jeremy Gaunt.)

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