Surging markets give Bank some respite but interest rate cut may still be needed

The Bank of England will have to cut interest rates if share prices tumble further to counter the impact of the huge destruction of household wealth so far, economists said yesterday.

A total of £520bn ­ the equivalent of £23,000 for each family in the UK ­ has been wiped out over the past two years, Oxford Economic Forecasting (OEF) said. If the impact of escalating household debt is included, net wealth has now dropped more than £680bn, a fall of 28 per cent or more than £30,000 each.

The impact of the report was slightly diluted by a surge in stock markets around the world yesterday that saw the FTSE 100 index rise 186 points, or 4.6 per cent, adding £44bn to share values. On Wall Street, the Dow Jones recorded its third biggest point rise, up 447.5, or 5.4 per cent, at 8711.9, while the Nasdaq rose 5.8 per cent to close at 1,335.2.

However, London share prices have now slumped more than a third since their peak at the end of 1999, with the market down 20 per cent in the past three months alone.

OEF said if the fall was sustained for another three months, the Bank might have to cut rates to offset the impact to "stabilise confidence". But any rate cut is unlikely to come this week, with economists in the City unanimous the Bank's Monetary Policy Committee will leave rates on hold at a 38-year low of 4 per cent when it meets tomorrow and Thursday.

Adrian Cooper, managing director of OEF, said: "I would be surprised if we did see it happening at the next meeting given that we have not seen the [US] Federal Reserve cut. But if the turbulence we have seen in the last two or three weeks continues then the prospect of a rate cut would become a real possibility." However, observers expect the MPC to perform a volte-face from a bias towards hiking rates to preparing the markets for a possible rate cut.

Andrew Smith, chief economist at the accountants KPMG, said: "The assumption that it is a question of when, not if, to raise rates has been overturned and rate cuts should be firmly back on the agenda until global recovery is more secure."

OEF estimates a 20 per cent fall in share prices sustained for six months would cut 0.7 per cent off GDP unless the Bank responded with a rate cut, in which case the impact would be just 0.2 per cent. It said the housing boom had offset the -impact of the stock market and dismissed fears of a speculative bubble, saying there would be a "slow landing" for the housing market with little risk that prices would fall.

Hopes that house-price growth would slow of its own accord were boosted by figures yesterday showing households drastically curtailed their borrowing last month, fuelling fears the consumer boom may finally have run out of steam.

The amount of mortgage lending and borrowing against credit cards, overdrafts and store cards both fell in June, the Bank of England said. Mortgage lending increased by £5.62bn last month, compared with May's £6.8bn jump, while unsecured loans rose £1.29bn from £1.44bn.

The number of new loans approved for house purchase fell to 105,000, from 123,000 in May, suggesting the slowdown was set to continue.

However, the Bank warned the figures might have been distorted by the jubilee bank holidays, which cut the number of working days to 18 from 21.

It said that without this effect, the number of mortgage approvals would be close to the average of 119,000 for the previous three months.