Bank of England May Cut Benchmark Interest Rate to Record Low

Bank of England May Cut Benchmark Interest Rate to Record Low


Jan. 8 (Bloomberg) -- The Bank of England will probably cut the benchmark interest rate to the lowest ever today as officials move closer to the limits of conventional monetary policy to fight the recession.

The Monetary Policy Committee, led by Governor Mervyn King, will trim the bank rate by half a point to 1.5 percent, according to the median forecast of 60 economists surveyed by Bloomberg News. This would be the bank’s fourth rate reduction since the global coordinated emergency cuts on Oct. 8.

Chancellor of the Exchequer Alistair Darling says the U.K. Treasury will need to play a bigger role in setting monetary policy if interest rates approach zero. The pound dropped to a record low against the euro last week on speculation the central bank will keep cutting borrowing costs as the recession deepens, stoking unemployment.

“The outlook for the economy is pretty bleak and the first half will be horrible,” said Stewart Robertson, an economist at Aviva Investors Ltd. in London, which manages about $230 billion in assets. “Whether the trough is zero or half a point, it doesn’t really matter now. We’re moving towards more coordination between the Bank of England and the government.”

Any U.K. rate cut today would bring the benchmark to the lowest since the Bank of England’s foundation in 1694. The European Central Bank has cut its key interest rate by 1.75 percentage points to 2.5 percent since early October, and may reduce it again next week.

Fed Action

U.S. Federal Reserve Chairman Ben S. Bernanke has already taken further steps to boost the economy. The Fed lowered the rate for overnight loans between banks to a target range of zero to 0.25 percent on Dec. 16 and said it would buy unlimited quantities of securities. Rates in Japan are also close to zero.

The Bank of England may too soon pursue so-called quantitative easing, where the government would authorize the central bank to buy assets including government securities and perhaps create money to pay for them.

“The closer interest rates come down to zero, the more the normal transmission mechanism and the operation of monetary policy has to be looked at,” Darling said in an interview with the Financial Times published yesterday. Prime Minister Gordon Brown has signaled that the government may be planning other steps to help businesses and consumers.

Lack of Ammunition

“The MPC is getting to the stage where it is almost running out of interest-rate ammo,” said Robin Marshall, director of fixed income in London at Smith & Williamson Investment Management. “We’re going to see quantitative easing and more bank recapitalizations. I can’t believe that what we’ve seen so far is sufficient to free up the banking system.”

Financial institutions are hoarding cash and a Bank of England survey last week showed they plan to constrict credit further even after the government unveiled a 50-billion pound ($75 billion) rescue plan last year. Mortgage approvals dropped to the lowest level since at least 1999 in November.

U.K. services shrank at close to the fastest pace in at least a dozen years in December, a survey by the Chartered Institute of Purchasing and Supply showed this week. Nationwide Building Society said that house prices fell by the most since 1991 and consumer confidence dropped to the lowest in at least four years.

The economy contracted 0.6 percent in the third quarter and may shrink further, prompting job losses. Unemployment rose at the fastest pace since 1991 in November and Marks & Spencer Group Plc, Britain’s largest clothing retailer, said yesterday it will cut 1,230 of its staff.

Inflation Forecast

The recession has also eased price pressures. The inflation rate fell to 4.1 percent in November from 4.5 percent the previous month. King predicted on Dec. 16 that the rate may drop below the 1 percent lower limit this year.

Policy makers cut the benchmark interest rate by 1 percentage point in December, refraining from a bigger reduction because it may prompt an “excessive” drop in the pound. The currency reached 98 pence per euro for the first time on Dec. 30 and dropped 23 percent last year.

“The situation remains grim,” said Neil MacKinnon, chief economist at ECU Group Plc in London and a former U.K. Treasury official. “They’ve got to continue to cut rates aggressively. It’s entirely possible that they’ll announce something about quantitative easing in the statement. They might say they’re giving such measures consideration.”

BLOOMBERG