Bank of England Cuts Rates, Says Inflation Will Slow

Bank of England Cuts Rates, Says Inflation Will Slow (Update4)

By Brian Swint and Jennifer Ryan

Dec. 6 (Bloomberg) -- The Bank of England cut its benchmark interest rate for the first time in two years, saying inflation is likely to slow as higher credit costs hurt economic growth.

The nine-member Monetary Policy Committee, led by Governor Mervyn King, reduced the bank rate by a quarter-point to 5.5 percent. Economists were the most split about today's decision in three years, with 28 of the 62 economists surveyed by Bloomberg News forecasting the central bank would lower rates.

``Conditions in financial markets have deteriorated and a tightening in the supply of credit to households and businesses is in train, posing downside risks to the outlook for both output and inflation further ahead,'' the bank said in a statement accompanying its decision in London today.

The slowest services growth in four years and surging money market rates led Bank of England policy makers to set aside concerns about faster inflation expressed just last week by King. With consumer confidence at its lowest since 2004, banks including Morgan Stanley say house prices may decline next year.

``This is likely to be the first of several rate cuts,'' said James Knightley, an economist at ING Financial Markets, who changed his forecast yesterday and predicted a reduction.

Market Reaction

The pound fell to near a 2 1/2-month low against the dollar after the decision. It touched $2.0237 by 12:44 p.m. in London, near the lowest since Sept. 28, compared with $2.0266 yesterday. The U.K. currency also traded at 71.91 pence per euro, from 72.11 pence yesterday, when it was the lowest since May 2003.

The U.K.'s benchmark is still the highest among the Group of Seven industrialized nations. The European Central Bank kept its key rate at 4 percent in Frankfurt today. The U.S. Federal Reserve twice has trimmed its key rate, now 4.5 percent.

King signaled the bank was planning rate reductions last month when he forecast the economy would slow ``sharply'' in 2008 after expanding more than 3 percent this year. Today's decision follows rate cuts by the U.S. Federal Reserve and the Bank of Canada as policy makers try to shield the economy from the fallout of the collapse of the U.S. subprime mortgage market.

``Although upside risks to inflation remain, which the committee will continue to monitor carefully, slowing demand growth should ease the pressures on supply capacity, bringing inflation back to target in the medium term,'' the bank said in its statement.

Brown's Woes

Slower growth adds to the woes faced by Prime Minister Gordon Brown as he attempts to revive the Labour government's popularity, which touched a 19-year low last month, according to pollster ComRes.

Opposition lawmakers have criticized Brown, who served as finance minister for a decade before taking over from Tony Blair in June, for encouraging consumers to rack up a record debt burden, which fueled a tripling of house prices since 1997. Brown signaled his backing for the bank's decision.

``As chancellor and as prime minister, he is always being prepared to back whatever decisions the MPC thinks it is appropriate to make but those are decisions for them,'' Brown's spokesman, Michael Ellam, said at his daily briefing shortly before the decision was announced.

For homeowners, each quarter-point cut in the central bank's benchmark rate shaves about 2.4 percent off monthly repayments on a standard mortgage of 200,000 pounds ($406,000), according to the Council of Mortgage Lenders. The payment would drop by 30.84 pounds per month to 1,275 pounds.

The impact of the subprime collapse, which caused lending between banks to seize up, is intensifying as institutions hoard cash to ensure they meet end-of-year funding requirements. The three-month Libor rate, a measure of borrowing costs for banks, climbed to 6.65 percent yesterday, the highest since Sept. 18.

Auction Today

The Bank of England loaned 10 billion pounds ($20 billion) for five weeks as it provided commercial banks with extra cash to help fund them until January. It allocated 16.1 percent of the total 62.2 billion pounds in bids that it received after the rate decision. The loans are at the benchmark interest rate.

``The credit squeeze has intensified,'' said Philip Shaw, an economist at Investec Securities in London, before today's rate decision. ``It's going to take longer for the money markets to return to normal than people thought a month ago.''

Higher money market rates sparked a run on Northern Rock Plc in September, the first on a U.K. bank in more than a century. The Financial Services Authority, the regulator overseeing the possible sale of the mortgage lender, said on Dec. 5 that mortgage lenders should brace for tighter credit conditions.

Votes for Cut

While two policy makers voted for a cut last month, King, Rachel Lomax, Charles Bean and Andrew Sentance expressed concern that inflation in the past month after crude oil reached a record $99.29 on Nov. 21 and food prices rose.

Consumers anticipate the inflation rate to rise to 2.8 percent, a survey by YouGov Plc showed last month, the most since the poll was first conducted two years ago. The Bank of England's inflation target is 2 percent.

Barclays Capital and nine other banks and research groups changed their forecasts yesterday to predict a rate cut after evidence that higher lending rates are starting to affect the wider economy.

Service industries from banks to airlines grew at the slowest pace since May 2003, according to a survey of purchasing managers by the Chartered Institute of Purchasing and Supply. The figures cover two-fifths of the economy.

Mortgage rates are also rising even though the bank's benchmark rate has been unchanged for the past five months. HBOS Plc said house prices fell for a third month in November, the worst streak for property values since 1995, suggesting the decade-long housing boom is coming to an end.

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