Page last updated at 13:50 GMT, Wednesday, 17 December 2008

Bank considered bigger rate cut

Bank of England
The Bank has trimmed rates from 5% to 2% in just three months

The Bank of England's rate-setting body voted 9-0 to cut rates to 2% this month and considered a bigger move, minutes from its meeting have shown.

The Monetary Policy Committee (MPC) agreed that a cut in the Bank rate from 3% to 2% was the minimum needed.

However, it avoided a deeper cut on concerns it could hit the pound and undermine confidence in the economy.

Analysts said the minutes indicated that UK interest rates would fall further in the months ahead.

The pound fell to another record low against the euro, with one pound worth 1.0867 euros, as expectations grew of further hefty rate cuts.

The weak state of the UK economy was also emphasised by the release of new unemployment data, which showed the highest jobless total for more than a decade.

Balancing act

The minutes showed that the MPC considered that a cut in the Bank rate to below 2% might be justified given the problems facing the economy.

The Monetary Policy Committee could soon be following the US Fed in cutting interest rates very close to zero
Jonathan Loynes, Capital Economics

However, the committee noted that financial markets were expecting a one percentage point cut, and "there was a risk that going further could cause an excessive fall in the exchange rate".

"There was also a risk that an unexpectedly large cut could undermine confidence in the economy more widely."

The MPC welcomed the temporary VAT cut that was introduced by Chancellor Alistair Darling in pre-Budget report.

"The timing of discretionary spending changes announced in the pre-Budget report and the cut in VAT were likely to be helpful in offsetting the downside risks to output growth in 2009," it said.

The committee also noted the importance of getting bank lending levels to recover.

However, it agreed that cutting the Bank rate was "not the right policy instrument to tackle supply constraints in the credit market".

"Further measures to underpin lending growth would be needed, building on the government's package announced in October to recapitalise and guarantee funding to the banks," the minutes said.

Inflation slowing

On Tuesday, the US Federal Reserve cut its key interest rate from 1% to a range of between zero and 0.25% in an attempt to revive the economy.

And nearly all analysts now expect the Bank of England to make further sharp cuts in UK interest rates in the new year.

"It's abundantly clear the MPC feels the stance of policy is still out of kilter with economic prospects," said Philip Shaw at Investec.

"We certainly think that another 50 basis point cut is due at the next meeting and our central case for interest rates remains they will dip below 1% in Q2."

Jonathan Loynes, chief European economist at Capital Economics, said: "December's MPC minutes and the latest labour market data support the view that the Monetary Policy Committee could soon be following the US Fed in cutting interest rates very close to zero."

On Tuesday, the latest inflation figures showed that the CPI rate dropped to 4.1% in November.

Although this was still well above the 2% target, the Bank of England governor, Mervyn King, said in a letter to the chancellor that inflation was set to fall "materially" below the target rate in the second half of 2009.

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