The FTSE 100 index ended 0.4 points lower at 5,939.9 after earlier gaining more than 100 points. The pound ended little changed at 68.9p to the euro.
The half-point cut to 5.5 per cent was welcomed as a sign that the Monetary Policy Committee was ready to act swiftly if necessary. Kate Barker, Confederation of British Industry chief economic adviser, said: "This decisive move is good news for industry at a time when trading is difficult in many sectors."
Mortgage lenders greeted the move as a pleasant surprise. Jim Chadwick, marketing director for Barclays Mortgages, said: "Recent rate cuts appear to have had a positive effect on consumer confidence."
Most lenders cut mortgage rates by half a point, taking the monthly payment on a pounds 100,000 interest-only mortgage down by pounds 30. The fall in the typical repayment on this mortgage since rates peaked in the summer has been nearly pounds 152. Savings rates are under review and are likely to be cut again.
Business and unions again reacted to a fall in borrowing costs by demanding another. John Monks, general secretary of the Trades Union Congress, said: "The Bank needs to continue the downward trend next month in order to avoid recession and secure recovery in 2000."
The Bank's statement linked yesterday's move to the inflation forecast to be published in next week's Inflation Report. It said: "The Committee's latest inflation projections implied that a further reduction in interest rates was necessary to keep inflation on a path consistent with the target of 2.5 per cent."
Since the November report evidence on growth has been mixed, but inflation signs have been good. The Bank's statement was not read as a strong hint at future rate moves.
City analysts remained divided about the outlook for the economy after the fifth rate cut in five months. "The lags are such that the Bank cannot do anything now to avert a recession," said Steven Bell, UK economist at Deutsche Bank. He predicted that the next few months would bring bad news on the economy, including an upturn in unemployment.
However, Neil Parker at Royal Bank of Scotland said the economy remained in good shape. He said: "This move seems to show some complacency on the part of the MPC about the inflation target. Some degree of caution is now needed or the Bank risks destabilising the economy."
Most analysts expect UK interest rates to fall to 5 per cent by summer, taking them closer to mainland European levels.
The European Central Bank yesterday kept interest rates on the Continent unchanged, despite growing signs of slowdown in the euro zone. Wim Duisenberg, ECB President, said there was "no significant upward or downward pressure on prices".
However, the ECB President indicated that benchmark European interest rates could fall below their current level of 3 per cent in coming months. He said: "Recent data seem to confirm our earlier assessment that there are downside risks for upward growth and that production may have slowed down around the turn of the year".
Mr Duisenberg emphasised that the level of the euro - which has declined to $1.13 from $1.16 at launch - was not yet a matter for concern. The ECB would intervene to stabilise the currency if it was "seriously out of line with fundamentals".
Analysts said there was no chance of a further ECB rate cut until the euro strengthened.
Outlook, page 19