Hopes for rate cuts rise as growth falls to zero

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The Independent Online

A sharp downwards revision of the growth figures has raised hopes that the Bank of England will reduce interest rates by the end of the year, with more aggressive reductions following in 2009.

The Office for National Statistics' downgrading of growth during the second quarter from 0.2 per cent to zero prompted many observers to revise their previous predictions for rates.

The pound traded lower, with dealers pricing in a reduction in the yield on sterling investments being made effective sooner rather than later; the pound hit a one-week low against the euro.

"This really does put a rate cut firmly on the agenda, although it is unlikely to come until we have seen the peak in inflation," said Brian Hilliard, an analyst at SG.

The disappointing news on growth came in a week when the minutes of the last meeting of the Bank of England's Monetary Policy Committee were published. These again showed a three-way split in voting, with only one member voting for a cut and one opting for a price hike, both of a quarter percentage point. However, the minutes also indicated that the case for a cut had been given a much more thorough airing than in previous sessions, and economists generally agreed that, while couched in their usual balanced fashion, the minutes could bear a slightly "doveish" interpretation.

There has also been a run of poor data on the housing market, investment and consumer and business confidence, and ambiguous evidence about consumer spending, adding to the pressure on the Bank to reduce the official cost of borrowing from the current 5 per cent.

Matthew Sharratt, UK economist at Bank of America, added: "We now believe the Bank is likely to start easing by year-end already, despite concerns about the near-term inflation profile. We had expected for some time that the Bank of England will cut the Bank Rate to 4.0 per cent by the third quarter of 2009. We now add a further cumulative half percentage point of easing to take rates down to 3.50 per cent by end-2009."

Voices from the "real economy" were also urging action. David Kern, economic adviser to the British Chambers of Commerce, said: "The revised GDP figures confirm that the Office of National Statistics' original second-quarter estimate was too optimistic. The messages signalled by our Quarterly Survey were more realistic. The figures show that manufacturing and construction declined in the second quarter, and total GDP stagnated. Given the heightened threats of UK recession, it is vital that the MPC starts cutting interest rates in October or Nov-ember, as soon as it is clear that CPI inflation has peaked."

As to timing, a consensus is emerging that November would be the ideal moment for the Bank to cut rates. By then, inflation should have peaked, at more than 5 per cent in September, and the growth estimates for the third quarter of the year will almost certainly point to recession. November sees the publication of the Bank's next quarterly Inflation Report, its definitive view of the economy, which will give it ample opportunity to explain why it is cutting interest rates when inflation will still be more than double the official 2 per cent target.

The previous assumption was for rates to remain on hold for the rest of this year with a cut coming in February, when inflation could be demonstrated to have embarked on a downward path. However, the accumulating evidence of a rapidly cooling economy has changed the climate of economic opinion in the City, as it may well do in the MPC itself.