Outlook: Bank's half measure may do the trick

GORDON BROWN and Eddie George must be reflecting that financial markets can be fickle masters. Yesterday the Bank of England cut interest rates by half a percentage point - the first time the cost of borrowing has changed by this much in nearly four years. Yet the FTSE-100 Index responded by falling 2.5 per cent.

In a world where everyone has grown used to niggardly interest rate movements of a quarter point in either direction, a cut of this magnitude is designed to affect sentiment as much as people's pockets. Neither the corporate sector nor private individuals are geared to anything like the extent they were during the 1980s boom.

Moreover, many households will not benefit immediately anyway from yesterday's rash of mortgage rate cuts because of the prevalence of fixed-rate deals and annual adjustments.

Unfortunately, the psychological message the markets drew from the Bank's decisive move was that there must be something even more unpleasant lurking in the woodshed. Why cut rates by half a point unless recession, or something worse, is on the horizon? It is a perverse logic but it is one that has been fed by the likes of the Confederation of British Industry and yesterday the markets chose to swallow it.

Still, the Chancellor will not be worrying too much. There is a pleasing symmetry to the way the week's two big events - his pre-Budget statement and the meeting of the Monetary Policy Committee - have complemented one another.

On Tuesday Mr Brown opened the door to what Treasury ministers would call "significant" rate cuts by forecasting that inflation would undershoot 2.5 per cent next year before returning to target.

Now the Bank has responded with a rate cut that may just make the Chancellor's optimistic growth forecasts for the next three years look that bit more plausible.

Mr George, meanwhile, can take heart from sterling's continued fall against the Deutschmark which makes life more bearable for exporters. If the sell- off is sustained, the pound will soon be in the zone which industrialists deem make them competitive again.

A half point cut was undoubtedly needed. There was enough justification for it even before the Bank decided it could no longer trust the average earnings figures - the main defence for keeping rates high. Since then more supporting evidence has piled in thick and fast on the international front and domestically - yesterday's industrial output, distributive trades and car sales figures being merely the latest ammunition.

So the Bank was right to act as it did. The question is whether or not it will do the trick. The answer yesterday from the equities market was confused. But if it is any consolation to Gordon and Eddie, Wall Street is now 6 per cent higher than when Greenspan treated the US markets to a similar surprise in October.