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Bank of England cuts key interest rate

The Bank of England cut official interest rates by a quarter of a percentage point Thursday to 4.5 percent, noting the risk that already sluggish household spending and investment growth in Britain could slow further.
/ Source: The Associated Press

The Bank of England cut official interest rates by a quarter of a percentage point Thursday to 4.5 percent, noting the risk that already sluggish household spending and investment growth in Britain could slow further.

The bank’s first move in rates since August 2004 had been expected by economists following weaker gross domestic product growth, sluggish retail sales, a downturn in manufacturing growth and a stagnating housing market.

In Frankfurt, the European Central Bank kept its benchmark interest rate unchanged at 2 percent Thursday, also as expected, despite calls for a cut from some euro-using nations who would like to spark their sluggish economies.

The Bank of England noted that output growth in Britain was subdued in the first half of the year.

“Although there are some signs of a pickup in consumer spending, downside risks remain in the near term,” the bank said. “Looking further ahead, however, the rise in equity prices and the recent fall in the exchange rate should boost activity.”

Retailers and business groups had led calls for the central bank to cut rates to bolster consumer confidence, despite signs that inflationary pressures in the economy are building.

The bank noted that higher oil prices could raise inflation further in the short term, but added that the “slackening in the pressure of demand on supply capacity should lead to some moderation in inflation.”

The 0.25 percentage point cut was necessary to keep inflation on track to meet the bank’s 2 percent target in the medium term, it said. Annualized inflation was 2 percent in June.

British banks and mortgage lenders quickly fell into line with the new rate, slashing their home-loan rates.

“This cut will be a catalyst for growth and will provide an essential boost to consumer and business confidence,” said Digby Jones, director-general of the Confederation of British Industry.

Economists were surprised last month by revisions to official data that showed the U.K. economy has grown below trend for four successive quarters. The Office for National Statistics reported that the annual rate of growth by the U.K. economy now stands at 1.7 percent — its slowest rate for 12 years — because of declines in manufacturing.

There has also been increased concern about the retail sector, which was already struggling, since terrorist attacks in London on July 7 that killed more than 50 people and a second round of attempted explosions on July 21.

Retailers have reported difficult conditions since Christmas, and research company SPSL said the number of shoppers fell to its lowest level for four years in July after the attacks.

Colin Stanbridge, chief executive of the London Chamber of Commerce, said that even before last month’s terrorist incidents, business confidence in the capital was at its lowest since the Iraq war started in 2003.

“Therefore today’s rate cut makes complete sense,” Stanbridge said. “It will help nudge both consumer and business confidence back in the right direction.”

Economists were divided on whether Thursday’s cut signaled the start of a series of reductions in the rate or a one-time correction.

Howard Archer, Chief U.K. Economist at Global Insight, said the bank is likely to return to a holding pattern in the near term while it monitors the strength of the economy and inflationary developments.

“Nevertheless, we expect interest rates to be down to 4.25 percent by the end of this year and to fall to 4 percent in the first half of 2006, as further below-trend growth and a modestly softer labor market reduces inflationary pressures and concerns,” Archer said.

The Bank of England raised its key interest rate five times between November 2003 and August 2004 from a low of 3.5 percent to 4.75 percent amid fears that inflation was accelerating, partly due to a housing boom. But it had frozen the rate since then amid signs of a slowing economy.

The bank’s base rate — called the repo rate — is based on its dealings with commercial banks, building societies and other institutions. Like the key rate set by the Federal Open Market Committee in the United States, it is used to create a ceiling for the rate banks can charge each other for overnight loans.