Curious case of rate-cut tigers turned pussycats

Why the pussyfooting? After cutting interest rates aggressively by 0.5 percentage points in November and December, the Bank of England's monetary policy committee reverted to a softly-softly approach yesterday when it lowered them by a quarter-point leaving the cost of borrowing in the UK at 6 per cent, twice the level in the euro-zone.

Given the weakness of inflationary pressure in industry and on the high street and the risks to growth, some observers in industry and the City say another half point reduction would have been justified. They would argue this is especially true since the minutes of previous meetings show there is a desire among some committee members to put monetary policy on a neutral footing neither stimulating nor restraining the economy. No one knows exactly where that level is, but the consensus is that it is about 5 per cent.

The MPC's statement gave little away. It cited the fragility of the international environment, the continued slowdown in domestic growth and evidence that pay pressures were subsiding as reasons for the rate cut, but gave no indication of why it saw the need for caution. On the contrary, the gloomy tone would have justified a much bigger move.

Analysts believe the MPC's reticence was governed by the lack of new evidence about how the economy is performing and the fact that the neutral level of interest rates is much nearer after a cumulative fall of 1.5 percentage points in borrowing costs since October. It certainly doesn't signal that rates have bottomed out.

The interest rate futures market is discounting official rates falling to 5 per cent or lower this year. Some economists see that happening by the summer.

Before the next meeting, the MPC will have the advantage of seeing the fourth quarter GDP figures and key quarterly business surveys from the Confederation of British Industry and the British Chambers of Commerce. Such surveys may prove a crucial guide to its next move.

David Walton, senior economist at the US investment bank Goldman Sachs, says the surveys will probably show a small blip upwards in confidence in January, as they often do at the start of the new year, in which case the MPC may decide to repeat yesterday's quarter-point cut in February.

Another drop in confidence could, however, trigger another half point reduction to boost demand.

The other piece of evidence that the MPC will have next time will be the Bank's quarterly Inflation Forecast, though it has proved a misleading guide to policy on several occasions in the past 18 months. For example, in November, the report appeared to suggest that, rates were low enough to ensure inflation did not undershoot the Government's 2.5 per cent target, but the MPC cut rates again in December by half a point.