Bank set on rate cut to revive economy

Policy makers at the Bank of England are poised to cut interest rates this week for the first time in two years to prop up the ailing consumer sector and kick-start recession-hit manufacturing.

City investors are betting on a quarter-point reduction in borrowing costs on Thursday, following mounting evidence that the economy has slowed sharply since the beginning of the year.

Mervyn King, the bank's governor, and his colleagues have been surprised by the sharp slowdown in consumer spending over the past six months, and are unlikely to want to disappoint the markets by leaving rates on hold for a 12th successive month.

This is despite a surge in corporate earnings and share prices last week, which saw the FTSE 100 hit a three-year high.

'They've talked themselves into doing it,' said John Butler, HSBC chief UK economist, who sees a 60 per cent chance of a rate cut this week. 'What will probably persuade them to do it in August is that GDP has come in more sluggish than expected.'

GDP growth is at its weakest for 12 years, according to official figures, and there are worrying signs that UK unemployment has begun to rise.

At its July meeting, the bank narrowly voted to keep interest rates on hold, with four of the Monetary Policy Committee's nine members recommending a cut. The MPC's quarterly Inflation Report (an assessment of economic prospects) will feature in decisions made in August. Past experience shows rates are twice as likely to be shifted in a month when the Inflation Report is published.

'The bank led the market to the water and now it looks like it's got to deliver,' said chief economist at F&C Asset Management Steve Andrew, who expects rates to be at 4 per cent by the end of next year.

Martin Temple, director-general of the EEF, the group representing engineering and manufacturing, said: 'With growth prospects weakening the bank has the perfect opportunity to calmly reassure business and consumers amid increasing economic and political uncertainty.'

The CBI and the British Retail Consortium have also backed the move.

Lenders say one rate cut is unlikely to reignite the housing boom, which has helped support consumer spending. 'I don't think it's going to cause a resurgence in the market,' said Martin Ellis, chief economist at Halifax, which this week will provide its own snapshot of the housing market.

Ellis added that the pattern for the rest of the year would be more of the same: 'We still hold to our view that over the year as a whole there will be a 2 per cent fall in prices.'

But Butler fears a rate cut could prolong the consumer borrowing binge that has seen total debt hit a trillion pounds. 'You may be supporting growth in the next six months but only by taking it away from next year. I think next year is when you get the aggressive cuts,' he said.