King springs surprise rate cut to 3.5 per cent

Borrowing costs at 48-year low, 'Hesitant' global recovery sparked Bank's move, Mortgage rates may fall

The Bank of England yesterday cut interest rates to their lowest level for almost half a century in a bid to prevent Britain's stagnating economy slipping into recession.

The Bank's Monetary Policy Committee, chaired for the first time by the new Governor, Mervyn King, cut the base rate by a quarter point from 3.75 to 3.5 per cent.

Interest rates have not been lower since 1954 when Winston Churchill was Prime Minister.

The move, which took many analysts by surprise, was greeted with delight by business leaders and trade unions, who have clamoured for a cut for several months.

Firms received a treble boost as the pound plummeted after the decision, making life easier for the UK's beleaguered export sector, while a fall in gilt yields will make borrowing cheaper.

The Bank took the rare step of issuing a statement with its decision in which said that the global economic recovery had "remained hesitant". "Output growth in the United Kingdom has recently been below trend," it said. "Although the preconditions for recovery remain in place, the prospect for external demand for UK output is weaker than previously expected."

It added that the recent rise in inflation was temporary, while growth in pay had been "subdued".

In a key remark, seized on by the markets, the Bank said it had taken account of the recent rise in sterling, which would feed through into lower inflation and weaker exports.

The pound, having fallen about 8 per cent earlier this year, has regained more than 3 per cent since the MPC last met in June, which makes life tougher for exporters.

Last week, Mr King used his first media interview to stress this was the most important piece of news since June.

John Butler, UK economist at HSBC, said: "King may be the new Governor at the Bank of England, but sterling is king."

Business organisations applauded what they called a "bold" decision. "The new Governor has started on the right foot by presiding over today's decision to cut rates," said David Frost, director general of the British Chambers of Commerce.

Stephen Radley, chief economist for the Engineering Employers' Federation, praised the "decisive" move to prop up domestic demand. "Whilst there is little the Bank can do about world markets, this will at least ensure growth remains on track at home until there is evidence of a sustained recovery."

Sterling tumbled over half a penny against the euro and fell a full cent to an eight-week low on the dollar while the index of the pound's exchange rate, which recently hit a three-month high above 101, fell below 100 yesterday.

Most analysts in the City had expected the Bank to wait until August when it had finished its latest quarterly forecasts for inflation and growth.

Further falls in sterling will probably prevent any fresh rate cuts, and yesterday 21 out of 35 City economists polled by Reuters said they thought rates had now troughed.

Philip Shaw, chief UK economist at Investec, which forecast the cut, said he expected the global recovery to build up steam. "On balance we expect today's move to be the last in the cycle," he said.

But Ciaran Barr, chief UK economist at Deutsche Bank, said further cuts could not be ruled out as soon as next month. "The economy will struggle to move above trend for some time and, in this environment, further cuts are to be expected," he said.

Homeowners will have to wait to see whether their mortgage lenders will follow suit with a cut to lending rates. Halifax, Nationwide and Abbey National said they were reviewing their rates while Barclays said it would make no decision until next week.

Smaller mortgage providers took the opportunity to get their cut in early, with Virgin One, Sainsbury's Bank and C&G passing on the full quarter-point.

Many providers were slow to react to February's rate cut, and many eventually chose not to pass on the full reduction, drawing criticism from MPs on the Treasury select committee.

There was also disappointment in Europe, where the European Central Bank kept rates unchanged at 2.0 per cent. The decision had been expected.

Wim Duisenberg, the ECB's president, hinted that rates in the eurozone had troughed, saying the worst of the economic downturn might be over.