AS ECONOMY SHRINKS

More UK rate cuts possible

11-13-2008 | REUTERS

The Bank of England suggested that it may cut interest rate below their current half-century low to ease recession effects

Panama Star In its gloomiest set of forecasts in more than a decade, the central bank said the economy had probably already entered recession and was likely to contract more throughout 2009.

Annual inflation, which is at 5.2 percent, would fall to just below 1 percent in two years, half the central bank's target, it forecast a week after making a shock 1.5 percentage point interest rate cut to 3.0 percent.

The pound tumbled to a record low against the euro and to a 6-year trough against the dollar as investors priced in more rate cuts.

"We are certainly prepared to cut Bank Rate again, if that proves to be necessary. There are many things to learn between now and our next meeting," BoE Governor Mervyn King told a news conference after the forecasts were published.

King refused to speculate how low interest rates would eventually need to go. But analysts are now predicting that borrowing costs could fall another percentage point to 2.0 percent and perhaps go even lower for the first time ever.

"The Bank of England's Inflation Report leaves us with the clear impression that the 150 basis point cut in the Bank Rate is not the end of the monetary policy stimulus," said James Knightley, economist at ING. "We had been expecting rates to fall to 2 percent by January, but we now favor rates falling further to 1 percent."

The BoE predicted the economy could shrink by a rate of nearly 2 percent in the first half of next year before growth returns to its long-run average in two years.

Figures out earlier showed the downturn is already hitting Britons hard. The jobless total rose to its highest level in more than a decade in the three months to September and could hit the 2 million mark by the end of the year.

The BoE faced accusations that it should have cut interest rates earlier to prevent the current downturn, and that it had been "caught with its pants down." But King struck an unapologetic tone, saying the events of the last two months had been unprecedented. "Since August, the world has changed, we have changed our forecasts," he said.

However, Chiara Corsa at Unicredit Markets & Investment Banking, said the BoE had admitted it had some catching up to do. "Today's inflation report is a courageous acknowledgment that they are definitely behind the curve,” said Corsa.