Bank of England signals rate cut possibility

Cutting interest rates beyond the record low of 0.5% remains a weapon to combat the weakening economy, the Bank of England indicated today.

Members of the Monetary Policy Committee (MPC) opted to pump more emergency cash into the economy earlier this month, but not before discussing in more detail the possibility of a first cut in rates since March 2009.

Minutes of the July meeting revealed the notion that a new £80 billion "funding for lending" scheme aimed at kick-starting bank lending could lessen fears about the impact of a rate cut on the margins of lenders.

In the end, members of the nine-strong committee voted overwhelmingly to keep rates on hold but admitted on the subject of interest rates that they will "review this option again". They voted seven-to-two in favour of increasing quantitative easing by £50 billion to £375 billion.

Vicky Redwood, chief UK economist at Capital Economics, said: "Members signalled that a rate cut was still possible further ahead, although only after the effects of the funding for lending scheme become apparent."

A reduced rate would be the lowest in the Bank's 318-year history, with a cut to 0.25% saving a borrower with an average lifetime tracker rate on a £200,000 mortgage £328.56 a year, according to comparison site Moneyfacts.

But lower borrowing costs would deliver yet another blow to Britain's savers, who have lost out since rates hit their current historic low in March 2009.

The Bank's main concern over a rate cut beyond 0.5% is the impact it could have on some banks' and building societies' ability to lend.

Lenders have assets, mainly mortgages, with interest payments contractually linked to the Bank's rate and a reduction below 0.5% might squeeze some lenders' interest margins to the point at which they become less able to offer new loans to customers.

The funding for lending scheme, launched last Friday by the Bank and the Treasury, is designed to unclog the flow of credit by offering banks cheap finance and cushion the impact of a rate cut on banks' margins.

Malcolm Barr, head of UK economic research at JP Morgan, said: "If take-up of the funding for lending scheme is high, particularly among the building societies, and the MPC begins to express a few doubts about the effectiveness of QE, then a cut in Bank rate would start to look more likely if more stimulus is still needed."

The minutes said the impact of the funding for lending scheme could "alter" its assessment of a rate cut, although this was unlikely to be for several months.

Under the scheme, British banks are being offered funding at low interest rates over a four-year period - but it will be directly linked to bank lending performance to encourage lenders to increase loan availability and reduce rates.

However, other analysts remained sceptical. Howard Archer, chief UK and European economist at IHS Global Insight, said: "The MPC is prepared to re-visit the case for lower interest rates, although the indications are that this will not happen any time soon and we remain doubtful that interest rates will go below 0.5%."

The economy is in a double-dip recession after contracting by 0.3% in the first quarter of 2012 and declining 0.4% in the final three months of last year.

Meanwhile, inflation has pulled back from 5.2% last September as the impact of the VAT hike fades and energy and commodity prices fall.

The near-term picture for growth is "somewhat weaker" than the Bank's assessment last May, the Bank's minutes added, and the UK is now potentially facing a period of two years where there has been "little or no economic growth".

Survey data continued to weaken in the month before the meeting, the MPC said, while there were increasing signs that the eurozone crisis was hitting UK growth.

The minutes added: "Information during the month suggested export prospects had weakened, which would further impede the UK economy's rebalancing away from domestic demand towards net exports."

PA