Downturn heralds 2.5pc interest rates

Experts said today's dire economic news - with grim prospects and plummeting share prices - raised the prospect that interest rates could be cut to 2.5 per cent or lower over the next year.

A half point reduction to 4 per cent now looks inevitable next month, analysts said, before rates are cut to 2.5 per cent or even as low as 2 per cent by the end of 2009 as policymakers seek to nurse Britain's ailing economy back to health.

The grim economic data has even raised the spectre of an emergency rate cut by the Bank of England ahead of the November vote.

Philip Shaw, economist at Investec Securities, said: "The Monetary Policy Committee (MPC) has little choice but to continue to cut rates aggressively.

"Today's figures reinforce our call of a 50 basis point cut at the next scheduled meeting on 6 November, that is, if global central banks can wait that long and there is not a further round of co-ordinated easing before then."

The UK has followed a raft of other countries in making what is seen as the first step towards global recession.

Ireland and Singapore are already in recession, France is thought to be on the brink having reported negative growth in the second quarter, while others across Europe are believed to be soon to follow suit.

The poor outlook may see a repeat of the globally co-ordinated action seen earlier this month, when central banks across Europe, the US, Canada and China reduced interest rates in the first such move since the 9/11 terrorist attacks.

The Bank of England has reduced rates four times in less than a year, but its hands have been tied by soaring inflation.

The Consumer Prices Index (CPI) - the official measure of inflation - has been rocketing to levels not seen for 16 years, hitting 5.2 per cent last month as energy and food bills race ahead.

Until this month's shock 0.5 per cent rate cut, the MPC had held rates at 5 per cent since April as a result of inflationary pressures.

However, as the Bank's Governor uttered the word "recession" for the first time in a speech this week, it has been said that perhaps the MPC was too slow in bringing rates down amid mounting signs of economic trouble.

Geoffrey Dicks, economist at Royal Bank of Scotland, said the Bank may be guilty of failing to cut fast enough, although he said many were caught out by the speed of the economy's decline.

"The events of September and early October unfolded at a speed that no-one could possibly anticipate," he said.

"Relatively, the MPC has been slow, but everyone has been behind the curve - the European Central Bank was even raising rates in June."

The Bank has faced a difficult balancing act amid the twin threats of an economic slowdown and rising inflation.

Inflation concerns have now fallen back significantly as the looming recession is set to bring CPI sharply lower - perhaps even so far below the Government's 2 per cent target that Mr King will be forced to write an open letter of explanation to the Chancellor.

The US has been aggressively cutting interest rates for some time as its economy has headed south, but this is not anticipated to be enough to prevent America from avoiding recession.

Some UK economists are now pencilling in two rate cuts in Britain to 3.5 per cent by the end of this year, with the potential for steep cuts for some time yet as the economy's downward curve continues.

Vicky Redwood, an economist at Capital Economics, said: "We expect GDP to contract by around 1 per cent next year and a further 0.5 per cent in 2010. But the way things are going, we wouldn't rule out a much sharper downturn. Either way, interest rates are set to fall sharply to 2.5 per cent or even lower next year."