Cut in UK interest rates expected

The Bank of England is widely expected to cut interest rates this week amid fears that the UK economy is heading towards a recession.

The Monetary Policy Committee is expected to reduce the official cost of borrowing by 0.25% to 4.75% when it announces the result of its two-day rate setting meeting on Thursday.

But some economists have predicted the MPC will go further and slash rates by 0.5% following some dire economic data in the past few weeks.

Most commentators now expect interest rates to end the year at 4.5%, before falling to as low as 3% in 2009.

Philip Shaw, of Investec Securities, said: “The world has changed rapidly over the past few weeks and we now expect the MPC to cut the official Bank rate by 25 basis points to 4.75% next Thursday.

“The pace of change in the financial landscape over the past three weeks has been frightening and has spread well outside the confines of the US.”

The latest economic figures show that activity in the manufacturing and service sectors has now fallen to record lows, while house prices fell at the fastest rate ever recorded during the year to the end of September.

Unemployment is rising and there are growing fears that the UK is heading for a recession after economic growth stalled during the second quarter.

At the same time, credit markets still remain illiquid with inter-bank funding costs soaring, leading to the threat of higher mortgages and borrowing costs for businesses.

Howard Archer, chief UK and European economist at Global Insight, said: “We expect evidence that the economic downturn is deepening, coupled with the heightened risk of a prolonged significant recession stemming from the serious financial sector problems and very tight credit conditions, to push the Bank of England into cutting interest rates on Thursday.”

Any reduction to the base rate would be the first since April, with the MPC previously holding off making cuts due to fears over inflation.

Inflation still remains stubbornly high at 4.7%, more than double the MPC’s target of 2%.

But it is expected to peak at around 5% next month, before falling rapidly during the first half of 2009.

Despite the lingering threat from inflation, Allan Monks, an economist at JPMorgan Chase Bank, expects the MPC to cut rates by 0.5% this week, lowering them to just 3% by the end of the third quarter of 2009.

He said JPMorgan was now forecasting that the UK would enter a “meaningful recession, rather than just one in name”, with a “deeper and more prolonged period of weakness” than previously expected.

Of the nine-strong committee, David Blanchflower, who has repeatedly called for the cost of borrowing to be slashed and who voted for a 0.5% cut last month, Sir John Gieve and Kate Barker are seen as likely to call for a cut, with another two votes needed for a majority.