MPC voted unanimously for 1% rate cut and more cuts are on the cards

18 December 2008 / by Rachael Stiles
The Bank of England's Monetary Policy Committee voted unanimously to cut interest rates to two per cent, the minutes from its December meeting have revealed. But they also implied that the one per cent cut in the rate could have been even bigger and it's likely that more cuts are on the cards for the New Year.

The MPC, which decides the base rate each month based on conditions in the economy such as inflation and lending, considered making a cut of more than one per cent when it met at the beginning of December.

The continuing fall in commodity prices, such as oil, meant that inflationary pressures no longer prevented the committee from making a reduction to the base rate, as was the case earlier in the year.

Instead of inflation breaching the target of two per cent, peaking at more than five per cent this summer, there are now fears of it going the other way and deflation has become the new threat. The committee agreed that "given the significant probability of undershooting the inflation target in the medium term, a cut of at least 100 basis points was needed."

Previous attempts to ease lending in the money markets, which included drastic cuts in interest rates of one and 1.5 per cent over the last two months, a £500billion rescue-package for the banks, and a reduction in VAT, have done little to improve conditions in the economy in the short-term, prompting the MPC to make another cut of one per cent.

The committee noted the lack of effect which the previous cuts have had on the banks' lending to individuals and businesses, and saw that "Bank Rate was not the right policy instrument to tackle supply constraints in the credit market." Rather, it said that "Further measures to underpin lending growth would be needed, building on the Government’s package announced in October to recapitalise and guarantee funding to the banks."

Analysis of output in the fourth quarter of 2008 and the first quarter of 2009 projected a gloomy outlook for UK businesses. "In the United Kingdom, many business surveys were at historically low levels, consistent with a recession." the minutes said.

A more drastic rate cut was considered, it said, but ultimately members adhered to the risk that more than a 100 basis points cut could have a detrimental affect on the strength of the pound against other currencies.

And their fears have proven to be justified, because the mere suggestion of a bigger rate cut sparked a further drop in the pound when the minutes were released yesterday, sending it down to a record low against the Euro.

Foreign exchange dealers saw the MPC's consideration of a cut of more than one per cent as a sure indication that they will cut the cost of lending further at their next meeting in January. While the MPC was trying to protect the pound by not slashing rates further, analysts have accused the Bank of England of welcoming the falling pound which is boosting exports while domestic demand is low.

A rate cut to 1.5 per cent is widely expected for the New Year, but some economists believe that the MPC could go even further, following the US Federal Reserve's lead, which cut rates to a record low of less than one per cent this week to stave off a deepening recession.

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