MPC cuts interest rates but warns against inflation

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The Independent Online

The Bank of England cut interest rates yesterday, but the widely anticipated 0.25 percentage point reduction did little to calm fears about the economy as the Bank warned of the threat of inflation.

The Bank's Monetary Policy Committee lowered the benchmark lending rate to 5.25 per cent, its second reduction in three months.

The Bank said reduced growth abroad, financial turbulence, tightening domestic credit conditions and slackening consumer demand all contributed to the need for the cut. But it also cautioned that higher energy and food prices could boost inflation sharply, and that some slowing of demand was necessary.

"The committee needs to balance the risk that a sharp slowing in activity pulls inflation below the target in the medium term against the risk that elevated inflation expectations keep inflation above target," the Bank said.

The Bank of England and the European Central Bank, which yesterday kept its rate on hold, are taking a warier approach to monetary policy than the US Federal Reserve, which slashed rates by a total of 1.25 points to 3 per cent in two moves last month. Some economists think the Bank and the ECB will have to abandon their caution and cut rapidly to avoid a recession.

The ECB kept rates at 4 per cent yesterday. Its president, Jean-Claude Trichet, has taken a hard line on inflation. But he signalled that the ECB could cut rates for the first time in nearly five years, citing "unusually high uncertainty" about economic growth.

The Bank of England has faced a succession of gloomy data showing the economy slowing after a long boom. Manufacturing output fell unexpectedly in December for the second month running, official figures showed yesterday. Sterling fell after the manufacturing figures were released. The pound has fallen almost 10 per cent since July, but the figures suggested that slowing global growth was wiping out the benefits of a weaker currency.

The FTSE 100 dropped 2.6 per cent as the MPC's decision disappointed those in the market who had been hoping for an aggressive half-point cut.

Alan Clarke, UK economist at BNP Paribas, said: "The Bank is not about to encourage expectations of aggressive easing at this stage. That is not to say that the Bank won't step up the pace of easing later in the year. We think it will, but for now the Bank is trapped between plunging growth prospects and sharply rising inflation."

The Bank's Governor, Mervyn King, has warned that 2008 will be its most difficult year since the Bank gained independence over monetary policy in 1997. Inflation is currently at 2.1 per cent but he is concerned that rising prices could send it over 3 per cent.

Trevor Williams, the chief economist at Lloyds TSB Corporate Markets, said: "We can probably expect to see a modest rate cut in the spring, most likely in May, when evidence of a slowdown will be clearer."