Britain's economy nears stagnation as BoE meets

Policymakers have to decide what is the best path for borrowing costs with inflation running at the highest rate since the central bank was granted the power to set rates in 1997 but with the economy looking increasingly vulnerable to recession.

Analysts polled by Reuters unanimously expect the central bank to leave rates on hold at 5.0 percent on Thursday as a series of indicators have pointed to slowing activity.

The economy grew at its weakest pace in more than three years in the three months to July -- just 0.1 percent, the National Institute of Economic and Social Research said.

That followed 0.2 percent growth in the three months to June and NIESR thinks a further slowdown in August is likely.

"The outlook for growth continues to deteriorate, with recession looking increasingly unavoidable," said James Knightley, an economist at ING.

"The consumer sector is bearing the brunt of the credit crisis with falling asset prices, negative real wage growth and rising unemployment taking its toll on sentiment and spending."

The FTSE-100 index of leading shares has fallen about 1,000 points since mid-May. The pound has fallen six cents against the dollar in the last few weeks.

Consumers' mood soured last month at its sharpest rate on record to a series low, according to the Nationwide building society which has been tracking consumer confidence since 2004.

And the number of Britons finding permanent jobs fell at its fastest rate since the aftermath of the 9/11 attacks in 2001, the Recruitment and Employment Confederation/KPMG said.

Bad news for Brown, BOE

An unrelenting wave of weak economic data has raised the chances of Britain entering its first recession -- two successive quarters of contraction -- since the slump of the early 1990s.

An increasingly gloomy public mood, exacerbated by rising unemployment and soaring living costs, will add to the woes of Prime Minister Gordon Brown whose Labour party looks likely to lose power at the next election due 2010.

Brown built his reputation presiding over a decade of prosperity at the helm of the finance ministry before taking over from Tony Blair last year.

A tough first year in office has seen his ratings plummet, the Conservative opposition race ahead in the polls and infighting erupt in the Labour ranks.

A quick economic turnaround would do much to improve Brown's fortunes, but there is unlikely to be much help from the Bank of England just yet. After all, the BoE's remit -- bestowed by Brown -- is to target inflation at 2 percent.

Inflation is already running at 3.8 percent and is expected to spike to around 5 percent. Reducing rates on Thursday could mean that inflation stays too high for too long.

While oil prices have tumbled from record highs near $150 a barrel in recent weeks, gas and electricity providers in Britain are ramping up their charges and food prices are still rising.

The British Retail Consortium said on Wednesday annual shop price inflation rose to 3.2 percent in July from 2.5 percent in June, with food prices up some 9.5 percent on the year.

On the other hand, raising rates to tackle the inflation threat could drive Britain into a nasty downturn -- and that could push inflation well below target.

The central bank is therefore expected to hold fire this month in the hope that the economy is slowing enough to reduce price pressures -- but not too much.

"We suspect that most Monetary Policy Committee members are still firmly in 'wait and see' mode and in no hurry to move interest rates, given the current major uncertainties surrounding both the medium-term inflation and growth outlooks," said Howard Archer, an economist at Global Insight.

However, many expect rates will have to fall eventually, once the spike in inflation is over, to keep the economy afloat.