Bank of England hints at interest rate cut

Labour's re-election prospects received a boost yesterday when the Bank of England dangled the prospect of a cut in interest rates in the run-up to a likely spring poll.

Minutes of the Bank's meeting earlier this month to decide the level of borrowing costs provided the first hint that rates could be on the way down in the New Year, following five increases between November 2003 and August this year.

The timing of the release of the minutes was welcome for Gordon Brown, who has faced mounting speculation in recent weeks that the deteriorating state of the public finances will force him to raise taxes in the event of a third successive Labour victory.

With evidence this week that higher interest rates have led to a cooling in the housing market, a cut in the cost of home loans would increase the spending power of consumers and boost the so-called "feel- good factor" over the coming months.

Operational control of interest rates was ceded to the Bank by Mr Brown in Labour's first week in office in May 1997 as a way of taking politics out of economic decision making.

The Bank's nine-strong monetary policy committee (MPC) has the task of keeping inflation at 2%, and while it voted unanimously in favour of keeping interest rates at 4.75% earlier this month, the City was surprised at the doveish tone of the minutes.

According to the record of the meeting, some members of the committee thought little had changed since the November meeting, and no change in interest rates was appropriate. "For others, the downside risk to the inflation projection had increased, but not enough to make a persuasive case for a reduction in interest rates."

The account suggests that those committee members thinking about the need for cheaper borrowing were more concerned about events outside the UK than about the domestic economy, but analysts believe the eventual trigger for a cut could be falling house prices.

Rob Carnell, an economist at ING Financial Markets, said: "We forecast the MPC responding to a weakening housing market and slower consumer spending growth by cutting rates by 0.25 percentage points in the spring of next year, and these minutes suggest the MPC is slowly swinging in that direction."

Jonathan Loynes of Capital Economics said: "The minutes are consistent with our view that, while another rise in interest rates cannot be ruled out completely, rates have probably now peaked and will fall in 2005 as the housing market downturn gathers pace, the downside risks to global growth increase, and inflation pressures remain subdued. We expect rates to start to fall in the spring before reaching 4% by the end of the 2005 and 3.5% in 2006."

Other analysts were more cautious, warning that it was far too early to say whether rates had peaked. With much riding on the strength of con sumer spending over Christmas and the New Year, some in the City believe that rates could be going up just as the prime minister is preparing to name the day for the election.

"We still expect the activity and price data to surprise the MPC on the upside over the next few months, and that the surprise will be sufficient to push rates up to a peak of 5.25% by the middle of 2005," said David Hillier of Barclays Capital. "If there isn't enough of this data to force the committee's hand in February, then there should be enough to force a 0.25 point increase in March or April followed by a final rise in May or June."