The Bank of England kept interest rates steady at 5.25 per cent yesterday following last month's surprise increase, but expectations of a further rise in borrowing costs this year remain.

Sterling fell against the dollar and euro, although the decision had been widely forecast, and interest rate and gilt futures leapt as investors revised their own rate expectations, scaling back bets that borrowing costs will rise much further.

But the mood remains cautious and most economists expect another increase before the end of June as policymakers try to tame above-target inflation and anchor price expectations.

"Markets are still poised for further tightening in the months ahead, and there remains a strong possibility that high inflation rates and concerns over wage setting may lead to additional tightening before rates peak," said Rob Carnell, an economist at ING.

Inflation was the likely trigger for last month's unexpected rate move, having spiked well beyond the Bank of England's 2 per cent target to 3 per cent in December, and the decision to freeze rates suggests price pressures may have since eased. Policymakers will have had early access to January's inflation data at their monthly meeting, a week before the numbers are made public.

The bank has been concerned that the higher cost of living might feed through to wage demands, but while there has been some evidence of a pick-up in wage deals, it was not enough to ring alarm bells.