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URGENT: Video shows beheading of second American journalist

DUBAI (Reuters) - The Islamic State militant group released a video purporting to show the beheading of U.S. hostage Steven Sotloff, the SITE monitoring service reported on Tuesday. A masked figure in the video also issued a threat against a British hostage, a man the group named as David Haines, and warned governments to back off "this evil alliance of America against the Islamic State", the monitoring service said. (Reporting by William Maclean, Editing by Angus MacSwan)

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Bank of England leaves UK rates unchanged, policy steady

By David Milliken

LONDON (Reuters) - The Bank of England kept the scale of its asset purchase programme unchanged at 200 billion pounds ($319 billion) on Thursday and said it would decide whether or not to extend it next month.

Britain's central bank also left interest rates at a record-low 0.5 percent, a decision which had been unanimously expected by economists polled by Reuters and caused no reaction from sterling or British government bonds.

Most economists predict the BoE to call time on the scheme, which uses newly created money to buy financial assets, mostly gilts, and was launched last March in an unprecedented attempt to boost an economy ravaged by a global credit crunch.

But they expect interest rate rises to be much further off.

Next month, the Monetary Policy Committee will have new quarterly growth and inflation forecasts, as well as official data which is expected to confirm the British economy ended a year-and-half of recession in the last three months of 2009.

This likely return to growth means most economists doubt the BoE will further expand the asset-buying policy though past policy surprises mean few will completely rule it out.

"The key question is whether the MPC will vote for a further extension of QE in February or whether it will announce a halt," said Simon Hayes, UK economist at Barclays Capital. "In the absence of any major downside news over the next few weeks we think the latter is the likelier outcome."

The BoE made no statement about the economy in an announcement after its monthly policy meeting, which as in December simply said the MPC would review the scale of quantitative easing at February's meeting once existing funds had been spent.

The expectation that the BoE will cease gilt purchases after February has been a major factor behind a fall in 10-year British government bonds last week to their lowest in over a year relative to German bonds.

"The Bank is now set to be buying gilts at a considerably slower pace than the rate of issuance with or without a small further extension to QE," said David Tinsley, UK economist at National Australia Bank.

"The Committee's job is therefore arguably increasingly to ensure a smooth transfer to the post-QE world, which they would probably see as involving some further move up in yields but nothing so dramatic as kill the recovery."

RISING INFLATION

The BoE's main role is to ensure consumer price inflation, currently 1.9 percent, remains close to 2 percent over the medium term.

A rise in value-added tax and base effects now 2008's sharp falls in oil prices have dropped out of the data mean inflation is likely to spike up to 3 percent in early 2010, but the BoE expects spare economic capacity to allow it to fall even if monetary policy remains loose.

Uncertainty about the strength of economic recovery is a key challenge for the BoE in judging when to start to raise interest rates or sell back some of the billions of pounds of gilts it has bought, not least because fiscal policy will be tightened sharply at some point after an election due by June.

"The BoE has done enough to ensure positive growth again, but it will take time for GDP to rise back to its trend level," said George Buckley, economist at Deutsche Bank.

"As such we believe the MPC will be cautious in tightening policy particularly given that households will be acutely sensitive to higher rates on account of high debt-to-income ratios," he said.

Surveys of purchasing managers in the services sector and manufacturing suggest a solid recovery is underway, but official GDP data in the third quarter turned out to be much weaker than these surveys implied, so economists are cautious about the outlook for 2010.

Moreover, how much the BoE has to tighten monetary policy in future years to avoid inflation will depend on how rapidly a future government cuts spending or raises taxes to rein in Britain's vast budget deficit.

"With sustainable, significant recovery very far from guaranteed, any policy tightening still looks a long way off," said Howard Archer, economist at IHS Global Insight.

"We expect interest rates to stay down at 0.50 percent until at least late-2010. Indeed, the Bank of England could very well delay raising interest rates until 2011."

(Additional reporting by Christina Fincher, editing by Mike Peacock)

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