Bank strikes sceptical note on euro rescue package as it faces up to higher inflation

The painful dilemma facing the Bank of England as it balances a faltering recovery, threats to stability from the eurozone and unexpectedly intense inflationary pressures in the UK was made plain in the latest minutes of the Monetary Policy Committee and the Bank's Agents Report, both published yesterday.

The Committee voted 9-0 to keep rates at their historical low of 0.5 per cent, where they have sat for more than a year, and to keep on hold the Quantitative Easing programme, which has injected £200bn into the economy.

But there is increasing uncertainty about the next movement in rates. Last year the MPC's members split three ways on occasions, and the current tendency to unanimity may owe something to the need to avoid appearing divided at a delicate moment, economically and politically. Most economists still expect rates to stay low until the end of this year.

Echoing remarks by the Governor, Mervyn King, when he launched the May Inflation Report last week, and his open letter to the Chancellor on Tuesday, the MPC minutes draw attention again to the fact that "the near-term outlook for inflation was somewhat higher than in February". The minutes went on: "Sterling had depreciated and oil prices had increased sharply since the time of the February Inflation Report. This meant that inflation was likely to remain above the target for longer than the Committee had then anticipated."

The damage that higher import prices – a combination of a depreciated pound and accelerating global commodity price inflation – is inflicting on the real economy was highlighted in the Agents' Report.

The agents report that: "Overall, materials costs continued to rise, in some cases sharply. Higher steel, plastic, timber and fuel prices were regularly cited as putting upward pressure on businesses' costs."

Earlier this week the Office for National Statistics reported that RPI inflation, at 5.3 per cent, stood at its highest since 1991, while the CPI, which does not reflect movements in mortgage bills which have pushed the RPI higher, hit 3.7 per cent, a 17-month record. British inflation is markedly higher than in Europe, the US or Japan.

However the MPC is also concerned about the impact that the crisis in the eurozone will have on British growth, given that the single currency area is the UK's largest trading partner. The Bank also identified an increased cost of issuing public debt as a key risk, and such thinking may have been behind Mr King's outspoken approval of the new Government's proposal to cut almost £6bn from public spending and the deficit shortly.

The MPC judged that "downside risks to growth in the near term had increased somewhat" in Europe, while sounding a sceptical note on the $1 trillion rescue package for the euro – "it was possible" that the European Stabilisation Mechanism (ESM) would succeed in restoring financial sector and private sector confidence.