LONDON, Jan 13 (Reuters) - The Bank of England kept its key interest rate at a record low on Thursday, judging that longer-term downward pressure on prices from a slowing recovery will ultimately quell a looming spike in inflation.
British consumer price inflation was 3.3 percent in November and is forecast to rise to 4 percent in the coming months due to higher food and fuel costs and last week's rise in sales tax -- putting the central bank under some pressure to raise rates.
But the BoE expects that by early next year inflation will fall back to its 2 percent target, which it has exceeded since December 2009. The economic recovery is still seen as too weak for this extended period of above-target inflation to trigger a longer-term spiral in wages and prices.
"Inflation is primarily being driven by temporary factors such as a rise in VAT, high commodity prices and past depreciation of sterling. Stripping away these factors reveals that underlying price pressures remain low," said Nida Ali, economic advisor to accountants Ernst & Young.
Economists polled by Reuters last week were unanimous in the view that the BoE would keep its interest rates on hold this month and make no change to the 200 billion pounds ($315 billion) of quantitative easing asset purchases conducted from March 2009 to February 2010.
There was no significant market reaction to the decision.
However, financial markets are now pricing in a strong chance of an interest rate hike as early as May, as they predict the BoE will be forced to take action to defend its credibility in the face of rising public inflation expectations.
"Pressure is mounting on the MPC," said Roger Bootle, economic advisor to Deloitte. "However, I continue to think that the rise in inflation will be temporary and believe that interest rates need to stay low if the economy is to stand any chance of weathering the enormous fiscal tightening."
Britain's coalition of Conservatives and Liberal Democrats aims to reduce the country's budget deficit to 1 percent of GDP by the 2015/16 tax year, down from 10 percent in 2009/10.