Bank was split over rates cut

Bank of England policy makers only just voted for a cut in interest rates earlier this month, Bank minutes showed today.

Confounding City analysts who had thought a vote for a cut was in the bag, the Bank's monetary policy committee (MPC) was deeply split. The MPC voted 5-4 in favour of a quarter-point cut to 4.5%, its first downward move in two years.

Mervyn King, the Bank's governor, along with the deputy governors, Rachel Lomax and Andrew Large, and the executive director, Paul Tucker, voted to keep rates steady. They thought it was too early to conclude that inflationary pressures had eased.

The minutes showed Mr King's camp arguing: "With oil prices likely to remain strong, producer input prices rising sharply, and an acceleration in unit labour costs since the turn of the year, it was too early to conclude that inflationary pressures had abated."

But the other five members, led by the Bank's chief economist, Charles Bean, thought not cutting rates would have damaged confidence and early action could prevent the need for bigger moves later.

"It seemed likely that the combined effect of high levels of household debt and the lagged impact of past interest rate increases had accounted for some of the unexpectedly sharp slowdown in consumer spending," the five argued, according to the minutes.

It was the first time the governor had been in a minority since the MPC was set up in 1997, after Labour came into power.

After the release of the minutes, sterling hit its highest level against the euro since July 7 and gained about a third of a cent versus the dollar. The rise in the pound indicated that market expectations of a further cut in rates had faded sharply.

"The fact that there was only a 5-4 vote in favour of cutting interest rates in August and the overall tone of the minutes undoubtedly reinforces the message from the August quarterly inflation report that not only is the Bank of England in no hurry to cut rates again, but that it is possible that August's reduction could turn out to be the only cut in this cycle," Howard Archer, the chief UK economist of the consultancy, Global Insight.

In its inflation report last week, the Bank said inflation would rise above its 2% target in two years' time, based on market assumptions of lower interest rates. The tone of the report led analysts to conclude that the Bank was reluctant to lower borrowing costs again.

The July inflation figures, released yesterday, which showed inflation rising to an eight-year high of 2.3%, may well reinforce those MPC members who favoured no change in interest rates.

Some economists, however, still think that another cut is in the pipeline as they believe the Bank is too optimistic over Britain's growth prospects.

"Further below-trend expansion and a modestly softening labour market will increasingly alleviate medium-term inflationary pressures and concerns, notwithstanding July's spike up in consumer price inflation," Mr Archer said.

Mr Archer believes another cut in rates is on the cards before the end of the year and that they will fall to a low of 4% by next spring.

Today's minutes contained two surprises: the closeness of the vote and the governor voting with the minority for the first time since the chancellor, Gordon Brown, gave the Bank the power to set interest rates.

After the release of the minutes, the Bank pointed out that Mr King and his predecessor Sir Eddie had publicly indicated their readiness to vote with the minority.

Mr King, when he was the deputy governor, told the Treasury selecr committee in January 2003: "I am certainly quite prepared to vote in the minority ... People are not trying to search artificially for a consensus. I think it is the merit of the process that collectively, as nine people, we make better decisions than any one of us would do alone."

Economists, however, said Mr King's vote was significant.

"This conscious decision to disagree with the majority would not have been taken lightly by the governor," George Buckley, the UK economist at Deutsche Bank, told Reuters.

"Clearly the above-target inflation projection published last week would have weighed heavily on the governor's mind in making his decision."