MercoPress. South Atlantic News Agency

Bank of England cuts rate to 1%, and hopes for the best

The Bank of England's Monetary Policy Committee voted on Thursday to reduce the official Bank Rate paid on commercial bank reserves by 0.5 percentage points to 1.0%. This marks the fifth interest rate cut since October, as the BoE seeks to encourage more lending and stimulate the UK economy which is officially in recession since December. Base rates stood at 5% last October.

On the bright side the bank admits that although the transmission mechanism of monetary policy was impaired, past cuts in bank rate "would in due course nevertheless have a significant impact", together with the recent easing in fiscal policy, the substantial fall in sterling and past falls in commodity prices, for stimulating activity as the year progressed. The MPC release says that the global economy is in the throes of a severe and synchronised downturn with output in the advanced economies falling sharply in the fourth quarter of 2008, and growth in the emerging market economies appearing to have slowed markedly. More over business and household sentiment in many countries has deteriorated and the weakness of the global banking and financial system means that the supply of credit remains constrained. In the United Kingdom, output dropped sharply in the fourth quarter of 2008 with business surveys pointing to a similar rate of decline in the early part of this year. Credit conditions faced by companies and households have tightened further while the underlying picture for consumer spending appears weak. "Businesses have responded to the worsening outlook by running down inventories, cutting production, scaling back investment plans and shedding labour", points out the release. MPC also welcomed UK government's latest measures to tackle the problems in the banking system, including the creation of an Asset Purchase Facility to buy high-quality corporate debt and similar assets. Describing the inflation situation, the release indicates that CPI inflation fell to 3.1% in December with diminished pay pressures, although sterling has continued to depreciate, boosting the cost of imports. "Inflation is expected to fall to below the 2% target by the second half of the year, reflecting waning contributions from retail energy and food prices and the direct impact of the temporary reduction in Value Added Tax. But the impact of changes in the rate of Value Added Tax, and the gradual pass-through of the depreciation in sterling, mean the path may be somewhat volatile". Finally MPC noted that, although the transmission mechanism of monetary policy was impaired, the past cuts in Bank Rate would in due course nevertheless have a significant impact. Together with the recent easing in fiscal policy, the substantial fall in sterling and past falls in commodity prices, that would provide a considerable stimulus to activity as the year progressed. Nevertheless, the Committee judged that there remained a "substantial risk of undershooting the 2% CPI inflation target in the medium term" at the existing level of Bank Rate. Accordingly, the Committee concluded that a further reduction in Bank Rate of 0.5 percentage points to 1.0% was warranted this month.