Bank dents interest cut hopes

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The Independent Online

Hopes that the Bank of England will follow America's lead with dramatic interest rate cuts were dashed today after policymakers warned the UK's inflation outlook had "worsened markedly".

Minutes of the January rates meeting highlighted the dilemma faced by the Bank's Monetary Policy Committee (MPC) after members raised concerns over a potent mix of slowing growth and rising inflation.

The minutes come amid growing calls for a 0.5 per cent cut in the cost of borrowing when the Bank next meets to discuss rates on February 6 and 7.

A shock decision yesterday by the US Federal Reserve to slash the cost of borrowing by 0.75 per cent has added to pressure on the Bank to lower rates.

But Bank Governor Mervyn King last night signalled that the UK would not follow America with similar emergency rate cuts to stabilise stock market and economic turmoil.

And today's minutes showed that the Bank was concerned that hasty rate cuts would suggest it was more concerned about preserving economic growth than keeping inflation under control.

Eight out of nine members of the MPC voted to keep rates on hold, with David Blanchflower the lone voice pressing for a reduction to 5.25 per cent.

The minutes showed the Bank's concerns that the short-term outlook for inflation had "worsened markedly" amid soaring oil and food costs and with energy price hikes on the horizon.

Mr King cautioned in a speech last night that inflation was set to continuing creeping up past the Government's 2 per cent target this year.

He told the Institute of Directors in Bristol that he may need to write one or possibly more open letters to the Chancellor - required when inflation hits more than 1 per cent above target.

But the minutes today showed the MPC's struggle to balance inflation with growth, as it said it there remained a "significant downside risk to UK activity".

It suggested it would rather digest next month's quarterly report on inflation before acting on rates.

The committee added that a cut immediately after the quarter point reduction in December might suggest the Bank was "focused more on stabilising demand than meeting the inflation target".

Jonathan Loynes, chief European economist at Capital Economics, said the minutes indicated that rates were set to come down, but perhaps less rapidly than expected.

He said: "It is quite clear that UK interest rates are heading lower in 2008, starting in February.

"The pace of monetary loosening will depend in part on conditions in the markets - if recent sharp falls in equity prices continue, the MPC may be forced to cut rates fairly quickly."

He added: "However, it looks likely that the committee will prefer to bring rates down at a relatively measured pace, perhaps one 25 basis points cut per quarter."

Mr King said in last night's speech that the UK economy faced its toughest challenge since 1997.

Inflation remained above target for the third successive month in December, at 2.1 per cent.

The committee said it believed inflation would rise "quite sharply" in the early part of 2008, with the latest round of energy bill increases adding to higher food and petrol costs.

Rates are widely expected to come down next month, in particular amid the stock market turmoil seen this week on fears of a US recession.

While a cut to 5.25 per cent is thought to be on the cards, the British Chamber of Commerce today urged the Bank to moves rates down by a half point to 5 per cent in the February vote.

The US Federal Reserve's surprise move to reduce rates caused a much-needed rebound in global markets.

London's FTSE 100 index soared 3 per cent yesterday after the US rates move, which came after a torrid start to the trading week.

On Monday, the Footsie suffered its worst one-day points fall since the September 11 terrorist attacks in 2001.

But more turbulence is expected, which may have a bearing on the Bank's February rates vote.

Howard Archer, chief economist at Global Insight, said: "We forecast rates to fall to 4.25 per cent by early 2009, however with the downside risks to the UK economy mounting, there is growing likelihood that rates will fall further and faster than this."

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