Governor hints at rate cut to avert slowdown

The Bank of England is debating a pre-emptive cut in interest rates to avert a slowdown in the consumer economy, Sir Edward George hinted last night.

The Governor said the "key question" facing the Bank was whether consumer spending would continue to prop up the economy and whether it should risk cutting rates "now" to sustain demand at the expense of encouraging consumers to take on even more debt. The speech appeared to pose a marked shift from its last interest rate meeting when it specifically ruled out a pre-emptive move.

The comments come against growing speculation the Bank will cut its growth and inflation forecasts next month to pave the way for a rate cut. Sir Edward admitted last night that the Bank was in a "quandary" over whether to cut rates next month.

He said recent sharp falls in world share prices had put a rate cut back on the agenda. However, market interest rates have fallen as investors rushed to price in another rate cut this year – a move Sir Edward welcomed as helping to sustain the recovery. "We find ourselves, not for the first time, in something of a quandary," the Governor told an audience of business leaders in Manchester.

He described the slump over the summer as a "nervous breakdown", which could be blamed on fears of fresh terrorist attacks, the raft of corporate governance scandals or a possible war with Iraq.

"Whatever the causes, the sharp further falls in equity prices have given rise to concerns about the strength of business and consumer confidence, and to doubts as the sustainability of the global recovery," he said.

Sir Edward laid out three questions the nine-strong MPC would have to answer when it met in three weeks' time:

Would the gradual economic recovery be sustained? Would consumer spending continue to prop up the overall economy of its own accord? How much risk would – or should – the Bank take if it cuts rates now to sustain consumer demand at the expense of higher household debt and house prices? But he added that cutting rates to boost consumer demand to "unsustainable" levels increased the risk of a sharp retrenchment further out.

His comments struck a gloomier note than his last speech three weeks ago when he said there was a "reasonable prospect that global demand will pick up gradually".

However, speculation of an imminent rate cut faded yesterday after inflation in the services sector – which makes up two-thirds of the economy - hit a nine-year high.

The headline rate of inflation that the Bank targets rose unexpectedly last month to 2.1 per cent from 1.9 per cent in August.

Although inflation remains well below the Government's 2.5 per cent target, the financial markets retreated from their position that a rate cut is on the cards. The figures showed that goods prices fell 0.9 per cent on the year, while services rose by 4.8 per cent, the strongest since 1993.