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U.K. slashes interest rates to historic low

The Bank of England cut official interest rates by a half a percentage point to 1.5 percent on Thursday, the lowest level in its 315-year history.
/ Source: The Associated Press

The Bank of England cut official interest rates by a half a percentage point to 1.5 percent on Thursday, the lowest level in its 315-year history as it attempts to ward off a prolonged recession.

The cut means officials are moving closer to the limits of conventional monetary policy after trims totaling 3.5 percentage points since the beginning of October as Britain faces its bleakest year since the early 1990s recession.

The bank’s nine-member monetary policy committee said the world economy “appears to be undergoing an unusually sharp and synchronized downturn.”

“Measures of business and consumer confidence have fallen markedly,” it said in a statement accompanying its decision. “World trade growth this year is likely to be the weakest for some considerable time.”

House prices have suffered their worst year on record, the huge services sector is shrinking at record pace and several major retailers have collapsed as consumers curb spending.

Inflation, meanwhile, is expected to fall from 4.1 percent currently to well below the government’s 2 percent target, heading toward destabilizing negative inflation.

“The Bank of England is now facing another balancing act,” said Hetal Mehta, senior economic adviser to the Ernst & Young ITEM Club. “Six months ago, it was juggling slowing economic growth with soaring inflation. But now the bank has to tread a path between avoiding deflation and a further weakening of sterling whilst doing all it can to soften the impact of the recession.”

A warning in the Bank of England’s latest credit conditions survey that lending to households and businesses is set to fall further in the first quarter of this year is likely to lead to more house price falls, corporate failures, and rising unemployment.

Policy makers are now more worried about inflation falling below target or turning negative. Deflation, a sustained drop in prices, can be disastrous for an economy by discouraging people from spending as wages fall and unemployment rises.

The half a percentage point cut was less dramatic than the 1.5 percentage point trim it announced in November, and lower than the 1 percentage point cut expected by some economists — but still brings the rate down to the lowest level since the Bank of England was founded in 1694.

Yet whether the lower rates will have the desired impact of jump-starting the economy is debatable, as many banks and other lenders have been slow to pass on previous cuts.

Nationwide, the country’s biggest building society, has already said it plans to invoke a “collar” clause enabling it to stop reducing rates on most of its tracker mortgages, which are designed to follow the benchmark interest rate.

In contrast, banks have been quick to pass on the lower rates to savers, who have watched the value of their nest eggs decline in real terms. Lower savings are unlikely to encourage consumer spending.

Meanwhile, Treasury chief Alistair Darling moved to quash speculation that the government was planning to print money to ease the impact of recession after he told the Financial Times in an interview published Wednesday that he was considering a policy of “quantitative easing.”

“Nobody is talking about printing money,” he told reporters after a Cabinet meeting on Thursday. “There’s a debate to be had about what you do to support the economy as interest rates approach zero, as they are in the United States. But for us that is an entirely hypothetical debate.”

Prime Minister Gordon Brown has said that with interest rates close to zero, the government should take fiscal action, hinting at further tax cuts and increased government spending.