More rate cuts likely as inflation is tamed

The depth and duration of the economic slowdown in the United States will be the crucial factor in deciding whether mortage rates for Britain's 11-million homebuyers continue to fall from their lowest level since the 1960s, the Bank of England disclosed yesterday.

In its quarterly inflation report, the Bank said the worsening international outlook had resulted in price pressures being weaker over the past three months than its nine-strong monetary policy committee had anticipated - and that despite five cuts in American interest rates this year it remained concerned about prospects for the world's biggest economy.

"Over the past quarter, much of the focus of the MPC's discussion has been on prospects for the US economy and the implications of those prospects for the rest of the world in general, and the UK in particular", Mervyn King, the Bank's deputy governor said. "It is still too early to be at all sure about how prolonged and how deep the US downturn will prove to be."

The report noted that "the risks to growth and inflation remain on the down side, associated particularly with the risk of a deeper or more prolonged slowdown in the US."

City analysts said the upshot of the inflation report was that interest rates had further to fall after the three quarter-point reductions this year.

Mr King said it was right that borrowing costs should have been reduced in smaller steps in the UK than in the US, because Britain had not experienced the boom followed by rapid shake-out of the economy seen in America. "We are setting interest rates for the UK, not the US", he said.

However, the report again highlighted differences of opinion between the members of the MPC, with one group urging a more aggressive approach to cutting rates.

This view, normally associated with Sushil Wadhwani and the now-departing DeAnne Julius, challenges the consensus view that inflation will gradually rise to hit its 2.5% target for the first time in four years by early 2003.

"Some committee members judge that the outlook for the world economy is likely to be weaker than in the central projection, and also believe that UK inflation is likely to be more sensitive to the global slowdown than assumed in the central projection.

"In addition, some members expect improvements in UK supply side performance and labour market performance will place greater downward pressure on inflation over the next two years than assumed in the central case."

Rate cuts have been confined to quarter-point moves by the strength of the domestic economy, where Mr King said the recent growth of consumer spending would prove unsustainable.

Money and credit growth have been robust, business investment has picked up and public spending will give a hefty boost to demand over the next three years. Despite the steady fall in unemployment, the Bank remains relatively relaxed about the tightness of the labour market, and sees it as posing little inflationary threat.