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Tuesday, 18 February, 2003, 21:41 GMT
Q&A: Surprise interest rate cut
The Bank of England has surprised most economists by cutting interest rates by one quarter of a percentage point.

After 14 months on hold, rates have been cut to 3.75%, taking borrowing costs to their lowest level since 1955.

BBC News Online finds out what it means for the economy.

Why has the Bank cut interest rates?

It is a sign of how worried they are about the economy.

Business confidence is at its lowest ebb since 11 September 2001.

And consumer spending, which has been the engine of the UK's economic growth, has shown signs of faltering.

Share markets have also fallen, with the FTSE 100 index losing 10% of its value in a month.

But why now?

The bank wants to head off trouble further down the line.

The key factor was inflation, which although edging a little higher, is still under control, making a rate cut feasible.

Meanwhile, demand in the economy is not quite as strong as the Bank expected it to be, making a cut, in the eyes of the Monetary Policy Committee (MPC) at least, desirable.

But the clinching factor is likely to have been figures showing a 4% fall in manufacturing output during 2002.

This was much was worse than expected and confirmed the UK's manufacturing sector is in deep recession.

The figures were not released to the public until Friday, but MPC members will have seen an advance copy before making their announcement on Thursday.

Why were the markets taken by surprise?

The City expected the Bank to wait until the situation in Iraq was resolved before acting on interest rates.

Most experts also thought the Bank would hold its fire for fear of giving fresh impetus to house price rises or high consumer debt levels.

Analysts and traders were not ready for such a bold, pre-emptive strike.

Even the bosses group the CBI, which has led calls for a rate cut, had fallen silent, expecting the bank to continue sitting on its hands.

Some analysts have expressed concern about the wisdom of a cut at this time, with the economy still in reasonably good shape.

Who will benefit?

Britain's manufacturers have been calling for an interest rate cut for months.

The CBI has predicted 42,000 job losses in the sector by April, which may have been a key factor in the bank's thinking.

Although a cut of a quarter of a percentage point is largely symbolic in value, it will give industry confidence that their concerns are being listened to.

It might also help to push Sterling down, helping exports.

And those individuals with variable-rate mortgages or other loans might see modest falls in their interest payments.

What are the risks?

It is a very bold move.

House prices are still rising, consumer spending is still fairly strong and many people are burdened with debt.

There is a real risk that all three of these indicators will continue to climb higher.

In which case, the prospect of a nasty crash at some point in the future becomes that bit more likely.

Will there be further cuts?

Some economists believe the bank is merely paving the way for more interest rate cuts once a war starts in Iraq.

Mark Cliffe, chief economist at ING Financial Markets, said: "We see this as a down payment for a further reduction once the shooting starts."

Most experts were predicting a fall to 3.5% by the end of the year, with some predicting rates as low as 3%.

What will that do to the economy?

Some analysts have said the bank is playing with fire by risking boosting the housing market, when prices are already increasing by 25% a year.

After all, it was not long ago that speculation centred on whether the bank would raise the cost of borrowing to put the brakes on the housing market and consumers' appetite for debt.

"If the equity and bond markets were worried about widening imbalances developing in the UK then they should be petrified now," said John Butler, UK economist at HSBC.

"Central banks are supposed to help reduce the risks rather than increase them."

Are we heading for a crash then?

The British economy has been running at two speeds for some time now.

Manufacturers have struggled, while consumer spending - and borrowing - races ahead.

Last week, Bank of England economist Charles Bean sounded a note of caution by speculating whether the UK could return to balance without too much trouble.

"Eventually spending will need to slow and the imbalances unwind.

"Achieving such a rebalancing smoothly would be quite an achievement," he said.

See also:

06 Feb 03 | Business
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29 Jan 03 | Business
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22 Jan 03 | Business
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