Bank cuts interest rates to 4.5%

The Bank of England today cut interest rates for the first time in two years amid overwhelming evidence of a weakening economy.

In a widely expected move, the Bank's monetary policy committee (MPC) reduced borrowing costs by a quarter of a percent to 4.5% after having left rates on hold for a year.

The Bank said in a statement: "In the first half of the year, output growth in the United Kingdom was subdued. Household spending and business investment growth have slowed."

The MPC came close to cutting rates last month, with four out of the nine committee members favouring a reduction. Since then, most data has pointed to a further loss of economic momentum.

There was a surprise bounce in Britain's dominant services sector last month, but that cut against the grain of most economic reports. Economists were surprised last month by revisions to official data showing that the UK economy has now grown below trend for four successive quarters.

The Office for National Statistics reported that the annual rate of growth by the economy now stands at 1.7% - its slowest rate for 12 years - while the labour market has shown signs of softening, with a steady rise in the number of people claiming jobless benefits.

On the high street, retailers across the country have reported difficult conditions since Christmas and Bank policy makers also have to gauge the impact of terrorist attacks on consumer confidence.

The research company SPSL said the number of shoppers fell to its lowest level for four years last month after the bomb attacks of July 7 and the failed bombings of July 21.

SPSL found numbers across the nation were down 2.4% last month compared with a year ago, and were at the worst level since 2001. Meanwhile, a recent Confederation of British Industry report said retailers had not seen an increase in sales since the end of 2004.

Although the Bank wanted to put the brakes on what it saw as an unsustainable consumer boom, it is now worried at the extent of the consumer slowdown. Meanwhile, manufacturing is in no position to pick up the slack as it has slipped back into recession.

The Bank raised interest rates five times between November 2003 and August 2004 from a low of 3.5% to 4.75%, amid fears that inflation was accelerating, partly due to a housing boom. But house prices have stagnated since the end of last year.

While it cut rates today, the Bank will want to stimulate consumer spending without reigniting house prices or encouraging more household debt, now standing at £1,000bn.

The UK's big banks - HSBC, Lloyds TSB and Royal Bank of Scotland have all reported a rise in bad debt, with more people falling into arrears on loan and credit card payments.

The Bank has also to watch out for inflationary pressures. With inflation hitting the Treasury's two-year target of 2% in June, the MPC will be cautious about lowering rates if there is a chance that it will be driven higher.

For City economists, the question is whether the Bank will cut rates again this year.

Howard Archer of the consultancy Global Insight thinks there will be more to come.

"Given some recent mixed data and survey evidence, the MPC seems likely to return to the sidelines for the near term at least, while it further monitors the strength of the economy and inflationary developments," Mr Archer said. "Nevertheless, we expect interest rates to be down to 4.25% by the end of this year and to fall to 4% in the first half of 2006, as further below-trend growth and a modestly softer labour market reduces inflationary pressures and concerns."