BoE MPC voted 8-1 to keep rates at 5 pct on May 8

LONDON (Thomson Financial) - The Bank of England's rate-setting body voted 8-1 in favour of keeping its benchmark interest rate on hold at 5.00 percent at its last meeting on May 8, with only Danny Blanchflower opting for a quarter point reduction.

The minutes to the meeting of the Monetary Policy Committee, published today, show that the majority, including governor Mervyn King, worried about the second-round effects of above-target inflation, even though the UK economy was beginning to slow in the wake of the crisis in credit markets.

'Although economic activity was likely to slow, the Committee had judged that some slowing in the growth rate of output was likely to be necessary for inflation to settle close to the target around two years ahead,' the eight members said.

'A further reduction in Bank Rate this month could create the impression that the Committee was trying to stabilise output growth rather than maintaining its focus on the inflation target,' they added.

At the meeting, the nine members of the panel were armed with the central bank's latest economic forecasts, which showed a high probability of the annual CPI inflation rate rising toward the 4.00 percent mark this year.

In the year to April, inflation rose to 3.00 percent, just shy of the level at which King would have to write to Chancellor of the Exchequer Alistair Darling explaining why inflation is more than 1 percentage point above the 2.00 percent target and what rate-setters plan to do about it.

The majority said the upside risk to the inflation outlook over the next two years was that the period of above-target inflation in the near-term would, by affecting inflation expectations, have 'a greater tendency' to persist than assumed in the central projection.

They also noted that reducing inflation from persistently high levels had in the past needed prolonged periods of sub-par growth.

The Committee had, the majority said, to make clear to those setting prices and wages that the period of above-target inflation would be 'temporary' and that it was 'committed' to returning inflation towards the target.

The BoE's central projection is for inflation to return towards the target by the end of this year and be around target after two years, subject to oil and commodity prices stabilising.

For arch-dove Blanchflower, the majority's focus on inflation expectations is largely misplaced, because the bulk of the price rises, such as oil and commodities, are beyond the MPC's control.

'With pay growth remaining subdued, this period of above-target inflation would have little tendency to persist,' he said.

'The current and prospective weakness of demand meant that there was a clear risk of missing the target on the downside looking further ahead,' he added.

Blanchflower doesn't look like he's the only one on the Committee worried about the extent of the slowdown in the economy though. The minutes showed that there is a range of views among the members about the extent to which tighter credit conditions and weaker income growth will weigh down on inflation.

'For some members, the economy had shown considerable resilience in the face of variation in credit conditions,' the minutes showed.

'For some other members, there was a significant risk that the impact of weakening property markets on the rest of the economy could be more substantial than implied by the central projection,' it added.