The last time the Bank cut interest rates from 3 to 2 per cent was October 26 1939, after Britain entered the second world war. The last time interest rates were at 2 per cent was in the final days of George VI’s reign in 1951.
Explaining its move, the Bank said that it believed demand was now so weak that there remained a substantial risk of undershooting the 2 per cent CPI inflation target in the medium term.”
The rate cut, while much larger than the Bank is accustomed to, is smaller than the 1.5 percentage point reduction made at the MPC’s last meeting in November and smaller than the money markets had begun to expect.
The cut suggests either that the MPC is less convinced than many private sector economists that deflation is a real possibility, or that it has other concerns about the impact of much lower rates, including worries over the slide in the pound. Sterling on Thursday fell to the lowest level against the dollar for six and a half years and a record low against the euro.
In its announcement, the Bank pointed to a number of fiscal measures in train”, both in the UK and abroad, aimed at boosting demand to counteract the current downturn. The minutes of the last MPC meeting showed that some members expressed a desire to see how the fiscal stimulus outlined in the government’s pre-Budget Report might affect demand before making any exceptional moves in interest rates.
The move comes after key purchasing managers’ index readings for the construction, manufacturing and services sectors hit record lows in recent days, with the future orders component of each index predicting that worse is to come.
In making its interest rate decision, the Bank expressed concerns about the flow of credit to businesses and households. Despite the actions taken to raise bank capital, ease funding and improve liquidity, conditions in money and credit markets remain extremely difficult,” it said.
Ominously, the Bank concluded that it was unlikely that a normal volume of lending would be restored without further measures.”
Interbank lending markets have seized up again, after a brief breathing spell following the government’s move to provide a £37bn taxpayer-funded lifeline to the nation’s banks. That suggests that the woes of the financial sector are still too great to allow it to resume its normal pattern of lending to households and businesses.
The Bank noted that while CPI inflation remains high at 4.5 per cent, the weaker outlook for activity in the near term and further falls in commodity prices have lowered that profile. The recent decision to cut value-added tax temporarily should also bear down on inflation in the near term, although that effect will be reversed in 2010.