UK cuts interest rates to 5.25%

The Bank of England cut the bank rate by a quarter-point to 5.25 per cent, as was widely expected, amid growing signs of a weakening UK economy., Financial Times 2/7/2008 5:33:06 AM

In a statement, the Bank said: The prospects for output growth abroad have deteriorated and the disruption to global financial markets has continued.”

It noted that credit conditions for households and businesses are tightening while growth in consumer spending has eased. Moreover, various business surveys show that further slowing is likely.

These developments pose downside risks to the outlook for inflation,” the Bank said, hinting that it believed price pressures now showing up in the economy were likely to abate later in the year.

It believed a quarter-point cut was necessary to meet the 2 per cent target for CPI inflation in the medium term.”

Analysts noted that the Bank’s statement was less doveish than some had hoped, and contained veiled warnings that inflation remains a concern.

It noted that higher energey and food prices are likely to raise inflation in the future while a weaker pound will raise the price of imports. Measures of inflation expectations are currently elevated,” it said pointedly.

Given this outlook for inflation, some slowing of demand growth, by reducing the pressue on capacity, is likely to be necessary to return inflation to target in the medicum term,” it added.

Thursday’s rate cut follows a survey of industrial production earlier on Thursday, which showed a 0.2 per cent drop in manufacturing between November and December and a drop of 0.1 per cent for the fourth quarter as a whole, compared with the third quarter. Revisions to prior periods were modest, but downward overall.

The latest data follow a variety of signs – from consumer confidence to bank lending and house prices – that suggest that demand is falling. Indeed, in a speech in Bristol last month, Bank of England governor Mervyn King hinted that he believed a 5.5 per cent bank rate might be too high for current conditions. His comment that the rate was bearing down on demand” was widely interpreted as a forerunner of Thursday’s rate cut.

Meanwhile, surveys of house prices show values flat to falling and demand for new mortgages falling so steeply that the number of new mortgage approvals has dropped to its lowest level since 1995, when the UK was emerging from a steep housing recession. The backlog of unsold homes is also growing.

Earlier this week, a widely-watched survey of consumer confidence, conducted by Nationwide, showed a sharp drop in January to the lowest level since the survey was launched in May 2004.

However, that survey also noted that consumers seem determined to go on spending money, highlighting the dilemma for the MPC.

January’s Purchasing Managers’ Survey, for example, showed a slight improvement to 52.5, indicating that the economy continues to grow, albeit at a slower pace. More worryingly, it also showed that even slower demand has failed to damp prices. Input costs – the price of goods used – continues to rise along with the prices charged by producers themselves, which hit a 10-month high.

The MPC is concerned that inflationary expectations are building, and will feed into wage demands.

Indeed, when the CBI unveiled its survey for the fourth quarter of 2007, it too pointed to robust underlying growth. Employment was expanding through the end of last year and prices were rising.

UK cuts interest rates to 5.25%