Bank weighs rate cut

The Bank's MPC is split 7-2 on the need for a rate cut

The Bank of England will announce at 1200 GMT on Thursday whether it will cut UK interest rates.

The announcement follows a two day meeting of the Monetary Policy Committee (MPC) to consider whether the UK should follow the US central bank, which reduced US rates by 0.5% last week.

The MPC has kept UK interest rates unchanged at 6% for 11 months, but it has come under growing pressure from business and trade union leaders to lower interest rates.

There is a need to boost business confidence at a time of economic uncertainty

Nick Reilly, CBI economic policy committee

The Fed acted because of fears of a sharp slowdown in the US economy, and there are worries that such a slowdown could adversely affect the UK economy as well.

But many economists believe the MPC will hold off from any rate cuts for at least another month or two, until it is clear whether the UK economy is actually slowing and inflationary pressures are easing.

However, the markets are predicting that UK interest rates will fall to 5.5% by the spring.

A rate cut could help revive the property market, which has shown signs of cooling in recent months, by making mortage interest payments cheaper.

But it would be bad news for savers, who would face lower savings rates. Some rates have already begun to fall in anticipation of a cut.

Pressure on the MPC

Business leaders have already called for the MPC to cut rates at its next meeting by 0.25%.

The head of the CBI's economic policy committee, Nick Reilly of Vauxhall, which is planning to close its Luton plant next year, said: "There is a need to boost business confidence at a time of economic uncertainty when firms may be hesitating over investment plans."

They argue that falling business and consumer confidence, as in the US, could cause a downward spiral of falling investment and falling demand.

Good Christmas

But consumer demand in the UK is still stronger than in the US, as evidence of reasonably strong Christmas sales demonstrates.

And the Bank is also worried about the possibility of higher wage growth boosting inflation, especially as unemployment is at a record low and most wage settlements will be negotiated in the first four months of the year.

However, with most economists - and the government - predicting that the UK's growth rate will slow from 3% in 2000 to about 2.5% in 2001, and with inflation consistently below the official target of 2.5%, the Bank's rate cut "doves" believe they will ultimately win the day.

"We expect to see the Bank of England cut rates in February or March," Lehman Brothers chief economist Michael Dicks said.

Worries about sterling

One reason for caution by some MPC members is the fear that a sharp fall in sterling could boost inflation.

As the US economy has slowed, the dollar has weakened in international currency markets, and the euro and, to a lesser extent, the pound have strengthened.

That makes goods imported into the UK more expensive.

Many people say that sterling is still too high against the euro, making manufacturing uncompetitive.

The worry is that a further sharp fall in sterling could give an inflationary shock to the economy.

Waiting for tax cuts

Another reason for caution by the Bank of England is the fear that in the run-up to a General Election, widely expected in the spring, the government will be tempted to cut taxes.

The chancellor, Gordon Brown, has argued that he is meeting his own prudent set of fiscal rules, and that he does not want a return to the "boom and bust" policies of previous governments.

However, he has also signalled that he plans further targeted tax cuts and spending boosts for key groups like pensioners and families with children.

He is also likely to argue that worries about the impact of a global slowdown, and his huge budget surplus, would justify further tax cuts.

But if the Bank does not see signs of the expected slowdown in the UK economy by spring, it may worry that the extra boost to spending from the tax cuts would be inflationary.