By Sven Egenter and Olesya Dmitracova
LONDON (Reuters) - The Bank of England is set to leave its policy settings on hold on Thursday as the economy looks to have skirted recession although a shock slump in February factory output served as a reminder that the economy is not on a sound footing yet.
The British economy has not recovered fully from the 2007-2009 slump and a contraction in the final three months of last year, due in part to the escalating euro zone debt crisis, had stoked fears of a new recession.
A surprise 1 percent slump in manufacturing output in February, unveiled on Thursday, showed that the economy was still on shaky grounds, after a recent slew of more upbeat business surveys had indicated that a modest recovery was on track.
The central bank will announce its policy decision at 1100 GMT, and all economists polled by Reuters predicted that the bank would leave interest rates and the target for its asset purchases unchanged, after it committed in February to buy 50 billion pounds ($80 billion) more of gilts.
The pound, which has risen in recent weeks as the prospect for further quantitative easing by the Bank of England (BoE) dwindled, dipped against the dollar on Thursday after the factory output data.
Most economists, however, hold the view that the BoE will not expand its quantitative easing program this year, and the recent output figures did little to change that.
"If I were on the MPC, I'd be more worried about whether inflation is coming back (down) as quickly as I thought," Tom Vosa from National Australia Bank said.
The Bank of England, along with the government, is forecasting that falling inflation will bring some relief to hard-pressed consumers and allow for more consumption.
But a recent spike in oil prices and rising food prices caused by a lack of rain in parts of England raised fears that British inflation will not fall towards the BoE's 2 percent target as fast as policymakers hope.
Economists said the economy should return to growth in the first three months of 2012 as the wider measure of industrial output grew in February thanks to increased energy production and the dominant service sector has also been improving.
In another encouraging sign that some consumers are confident enough to spend more, new car registrations rose by 1.8 percent in March, data showed on Thursday.
"Domestic demand for new cars is showing signs of recovery," said SMMT chief executive Paul Everitt.
Consumers have taken a hammering from a combination of the government's tough austerity measures to reduce a hefty budget deficit, rising prices that have outpaced wage growth, and the relatively higher cost of credit from banks compared to previous years.
Even a minor technical recession - defined as two consecutive quarters of falling GDP - would come as a major blow to finance minister George Osborne, who defended his tough spending cuts in last month's budget.
The Conservative Party, the dominant partner in the governing coalition with the Liberal Democrats, has so far defended its lead in the polls when it comes to economic policy.
However, a poll showed on Thursday that Prime Minister David Cameron's approval rating has tumbled to its lowest level since he was elected two years ago, after two weeks in which policy gaffes and a funding scandal battered his Conservative Party.
With the government's hands tied by its pledge to erase the budget deficit in order to protect Britain's cherished top-notch credit rating, the onus to boost growth has been firmly on the Bank of England.
And a sizeable minority of economists still expect more stimulus from the BoE but not until May at the earliest, when its current asset buys are completed.
By then rate-setters will have also seen the first reading of Britain's first-quarter GDP and updated their growth and inflation forecasts.
(Additional reporting by David Milliken; Editing by Hugh Lawson and Susan Fenton)