Bank cuts interest rates

The Bank of England today surprised the City by cutting interest rates for the second time this year, pushing the cost of borrowing to its lowest level since the early 50s.

In its first interest rate decision under Mervyn King, who succeeded Sir Edward George as the Bank's governor at the beginning of this month, the monetary policy committee reduced interest rates by a quarter-point to 3.5%.

"The global economic recovery has remained hesitant. Although the preconditions for recovery remain in place, the prospect for external demand for UK output is weaker than previously expected," the Bank said

Those hoping that Mr King would start his tenure at Threadneedle Street with a flourish were delighted as the MPC did the unexpected. Ahead of today's decision, City economists, by a majority of two to one, had thought that rates would stay on hold.

Mr King has a reputation as an inflation hawk but, in an interview last week, hinted that he was prepared to shatter preconceptions. He acknowledged that a rebound in sterling in recent weeks might have a negative impact on growth.

"I think we would expect to see a recovery during the course of this year, and a noticeable recovery, but we are not sure.

"Perhaps the most significant change in the past month has been the rise of the exchange rate - it has gone up 3%, and that again will make some difference in the outlook for growth.

"This will have to be factored into our decision," Mr King told the Times.

Yesterday's grim trade figures, which showed Britain's trade deficit unexpectedly widening to ?4.1bn in May, dashed hopes that a weaker pound at the beginning of the year had helped lift exports to provide a fillip for economic growth.

With sterling strengthening, Mr King's concerns about growth appear to be more than warranted.

"The MPC is acknowledging... that sterling's depreciation has partly reversed and also the fact that output growth in the first quarter and probably in the second quarter as well has been pretty weak and there has been a slowdown in the consumer," Alan Castle, economist with Lehman Brothers told Reuters.

Growth has tapered off considerably this year. Revised data for the first three months of the year showed growth of just 0.1%, the weakest performance for a decade.

Indications of a slowdown in consumer demand, a cooling in house price inflation and the continued slump in manufacturing have all prompted calls from businesses and unions for lower rates.

Ruth Lea, head of the Institute of Directors' policy unit, said: "There is little doubt that the global economy is in the doldrums, with the major economies all having deep-seated problems.

"Domestically, consumer spending and the housing market - the part of the economy that underpinned growth last year - are now moderating."

The Bank last cut rates in February. Minutes from the most recent meetings showed that most of the nine MPC members were waiting to see whether a lower pound had fed through to higher growth. Last month, three members voted in favour of a cut.

In lowering rates, the Bank is bringing borrowing costs more into line with those in other major economies.

In the US, the Federal Reserve has pushed rates down to 1%, while borrowing costs in the eurozone are at 2%. There was a risk that a decision to keep interest rates in the UK at 3.75% would have reinforced sterling's upward trend, choking exports and hurting growth.