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UK: Rates may sink to lowest since 1694

January 05, 2009 | "The Telegraph"

The Bank of England is this week poised to cut interest rates to the lowest level in its 300-year history, in the latest sign of the severity of the economic crisis.

The Monetary Policy Committee (MPC) is widely expected to use its two-day meeting this week to cut the benchmark Bank rate below its current 2pc level – the first time this has been done since the Bank was founded in 1694. The radical move is regarded as essential if the UK is to stand any chance of avoiding slipping into a Japan-style depression.

But despite expectations that the Bank may consider cutting borrowing costs, some experts are warning it may yet shock the market by leaving rates on hold due to the slide in the pound and the renewed health of the interbank borrowing markets.

Markets are pricing in a half percentage point cut to 1.5pc, bringing the Bank rate ever closer to the zero point at which it must start seeking alternative ways to stimulate the economy. At its last meeting it voted unanimously for a one-percentage point cut in borrowing costs.

With the Federal Reserve having cut US rates last month to just above zero and signalling that it intends to leave them there for some time, the MPC may follow suit with a strong hint that borrowing costs will be low for some time.

The expected move comes alongside growing evidence that the economy is heading for its biggest slump since the Second World War and its worst period of deflation since the 1930s. With most statistics showing the economy has slid further towards recession since last month, the Bank seems unlikely to change its course, according to most experts.

The main obstacle to a significant cut in borrowing costs is the weakness of the pound. With sterling having fallen by the biggest margin since Britain was forced to abandon the Gold Standard in the 1930s, many worry about the possibility of a full-scale run on the currency, while the Bank is conscious that the weaker pound should help support the economy, alongside lower borrowing costs.

Stephen Lewis, of Monument Securities, said: “[The Bank] may conclude that if the market is looking for a 50 basis points Bank rate cut in January, it would be safe to deliver easing on that scale.”

However, Simon Ward, economist at New Star, said: “I don’t think the arguments [for lower rates] have intensified at all. Sterling’s effective rate is some 10pc lower than at the last MPC meeting.”

By Edmund Conway

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