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Last Updated:  Friday, 21 March, 2003, 11:25 GMT
Bank rejects deflation risk
Bank of England
The Bank of England looked back to the Great Depression

The risk of deflation in the UK is very small and interest rates are unlikely to fall to zero, the Bank of England has said in a research report.

The research paper addressed what options bankers would have in a situation where interest rates were near zero and policymakers needed to stimulate the economy.

But it sounded an optimistic note for the UK economy.

"The risks of hitting the zero bound are small and the risk of entering a deflationary spiral are very small indeed".

Inflation is currently running at 3% in Britain, well above the 2.5% target set by the government.

Avoiding recession

Questions have been raised over what to do in a possible deflationary environment since the US lowered its interest rates to 1.25% last year - their lowest level for more than 40 years.

There have also been suggestions that the US may be forced to cut its rates even further in a bid to boost economic growth and avoid another recession.

The Federal Reserve said earlier this week that it would be ready to cut rates if the war with Iraq took its toll on the economy.

In the UK, suggestions of a slowdown in the house price boom and in consumer spending have prompted speculation that the Bank of England will cut interest rates from their current 3.75% at its next meeting.

(The figures are) not sufficient to concern the Monetary Policy Committee
David Page, Investec

However, inflation has remained more resilient than expected, rising to 3% last month - its highest level since May 1998.

Prevention in place

The Bank of England's report looked to the current situation in Japan and the 1930s in the US for examples of when rates were close to zero and prices falling.

It also considered alternatives to conventional monetary policy, such as devaluing the currency by printing money.

It said nothing precise could be inferred from any of these situations but confidently predicted that the UK would never find itself in such a dramatic situation.

"Since the risks of hitting the zero bound in pursuit of an inflation target like that in place in the United Kingdom are likely to be very small, we might nevertheless conclude that there is enough 'prevention' built into the UK monetary framework."

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