Although output in the United Kingdom has expanded at a brisk pace for the past two years, there are now signs that growth has begun to slow,” the Bank said in a statement released alongside the decision.
Conditions in financial markets have deteriorated and a tightening in the supply of credit to households and businesses is in train, posing downside risks to the outlook for both output and inflation further ahead.”
Market reaction to the decision was initially limited, as investors had largely priced in a quarter point rate cut after a clutch of weak data on Wednesday suggested the economy was slowing more abruptly than policymakers hoped.
The quarter point cut marks a turning point after a succession of interest rate rises that began in August 2006, and could restore some confidence to investors and household borrowers shaken by the recently renewed turmoil in credit markets.
Business and housing industry associations welcomed the cut and Halifax, the UK’s biggest mortgage lender, said it would reduce its standard variable rate from 7.75 per cent to 7.5 per cent from the start of January.
Steve Radley, chief economist at the EEF manufacturers’ organisation, said the move would reassure business that the Bank is on the case and help to cushion the economy from the worst effects of instability in the financial markets”.
Most analysts had thought the Bank would wait for firmer evidence of a slowdown before cutting rates, but several wavered or changed their call at the eleventh hour after the release of very weak surveys on house prices and service sector activity.
The MPC signalled in its November inflation report that rate cuts were needed to stop inflation falling too far in the medium term, but members had given few hints of when they would start to ease policy.
By voting to cut rates, the majority of MPC members has opted to pre-empt a sharp slowdown in output growth, rather than focussing on the risks of rising oil and fuel prices and evidence that producers and retailers still feel able to raise prices.
Forward-looking surveys of households and businesses suggest spending is moderating, broadly in line with the projections contained in the November Inflation Report,” the statement said.
Higher energy and food prices are expected to keep inflation above the target in the short term. Although upside risks to inflation remain... slowing demand growth should ease the pressures on supply capacity, bringing inflation back to target in the medium term.”
The Organisation for Economic Co-operation and Development said in its economic outlook for rich countries published earlier on Thursday that the Bank of England could probably afford to ease monetary policy without risking additional inflationary pressures”.
Peter Spencer, chief economic advisor to the Ernst & Young Item Club said the decision was little surprise”, arguing that if effective interest rates had remained at these artificially high levels for much longer, the MPC would have risked a recession in the economy next year.”
Others began to speculate on the prospect of a further rate cut early in the new year. The accompanying statement gives no indication the Bank sees this move as a one-off fine tuning exercise,” said Richard McGuire, strategist at RBC Capital Markets, adding that lenders’ reaction to the cut could influence the timing of the Bank’s next move.
Any indication lenders are opting to use today’s ease as a means of restoring margins rather than pass it on to borrowers would argue for some imperative to ease again in short order,” he said.