The nine-member Monetary Policy Committee, led by Governor Mervyn King, reduced the bank rate by a quarter-point to 5.5 percent. Economists were the most split about today's decision in three years, with 28 of the 62 economists surveyed by Bloomberg News forecasting the central bank would lower rates.
``Conditions in financial markets have deteriorated and a tightening in the supply of credit to households and businesses is in train, posing downside risks to the outlook for both output and inflation further ahead,'' the bank said in a statement accompanying its decision in London today.
The slowest services growth in four years and surging money market rates led Bank of England policy makers to set aside concerns about faster inflation expressed just last week by King. With consumer confidence at its lowest since 2004, banks including Morgan Stanley say house prices may decline next year.
``This is likely to be the first of several rate cuts,'' said James Knightley, an economist at ING Financial Markets, who changed his forecast yesterday and predicted a reduction.
Market Reaction
The pound fell to near a 2 1/2-month low against the dollar after the decision. It touched $2.0277 by 1:35 p.m. in London, compared with $2.0266 yesterday. The U.K. currency also traded at 71.91 pence per euro, from 72.11 pence yesterday, when it was the least since May 2003. Bonds fell, pushing up the yield on two- year gilts by 5 basis points to 4.511 percent.
Royal Bank of Scotland Plc lowered its forecast for rates in the U.K., predicting the bank rate will touch 5 percent by May.
``We continue to expect sizeable easing in the year ahead,'' said Michael Saunders, an economist at Citigroup Inc. ``Our base case is for rates to fall by a further 50 basis points. But the outlook is exceptionally fluid, and risks are on the side of greater easing over time.''
The U.K.'s benchmark is still the highest among the Group of Seven industrialized nations. The European Central Bank kept its key rate at 4 percent in Frankfurt today. The U.S. Federal Reserve twice has trimmed its key rate, now at 4.5 percent.
King's Signal
King signaled the bank was planning rate reductions last month when he forecast the economy would slow ``sharply'' in 2008 after expanding more than 3 percent this year.
``Although upside risks to inflation remain, which the committee will continue to monitor carefully, slowing demand growth should ease the pressures on supply capacity, bringing inflation back to target in the medium term,'' the bank said in its statement.
Slower growth adds to the woes faced by Prime Minister Gordon Brown as he attempts to revive the Labour government's popularity, which touched a 19-year low last month, according to pollster ComRes.
Opposition lawmakers have criticized Brown, who served as finance minister for a decade before taking over from Tony Blair in June, for encouraging consumers to rack up a record debt burden, which fueled a tripling of house prices since 1997. Brown signaled his backing for the bank's decision.
``As chancellor and as prime minister, he is always being prepared to back whatever decisions the MPC thinks it is appropriate to make but those are decisions for them,'' Brown's spokesman, Michael Ellam, said at his daily briefing shortly before the decision was announced.
Impact on Homeowners
For homeowners, each quarter-point cut in the central bank's benchmark rate shaves about 2.4 percent off monthly repayments on a standard mortgage of 200,000 pounds ($405,000), according to the Council of Mortgage Lenders. The payment would drop by 30.84 pounds per month to 1,275 pounds.
``A reduction in interest rates is exactly what the market needs and will benefit consumers,'' CML Director General Michael Coogan said. ``This will reduce the risk of payment shock for the 1.4 million borrowers coming off fixed rates in the next year.''
The impact of the subprime collapse, which caused lending between banks to seize up, is intensifying as institutions hoard cash to ensure they meet end-of-year funding requirements. The three-month Libor rate, a measure of borrowing costs for banks, was 6.64 percent today, near the highest since Sept. 18.
Auction Today
The Bank of England loaned 10 billion pounds for five weeks as it provided commercial banks with extra cash to help fund them until January. It allocated 16.1 percent of the total 62.2 billion pounds in bids after the rate decision. It also loaned 8.7 billion pounds in a one-week money-market auction.
``The credit squeeze has intensified,'' said Philip Shaw, an economist at Investec Securities in London, before today's rate decision. ``It's going to take longer for the money markets to return to normal than people thought a month ago.''
Higher money market rates sparked a run on Northern Rock Plc in September, the first on a U.K. bank in more than a century. The Financial Services Authority, the regulator overseeing the possible sale of the mortgage lender, said on Dec. 5 that mortgage lenders should brace for tighter credit conditions.
While two policy makers voted for a cut last month, King, Rachel Lomax, Charles Bean and Andrew Sentance expressed concern about inflation in the past month after crude oil reached a record $99.29 on Nov. 21 and food prices rose.
Inflation Concern
Consumers anticipate the inflation rate to rise to 2.8 percent, a survey by YouGov Plc showed last month, the most since the poll was first conducted two years ago. The Bank of England's inflation target is 2 percent.
``No doubt there will be some ritual bleating about the MPC cutting rates at a time when inflation is above target and set to rise further, but monetary policy is supposed to be pre- emptive,'' said Ian Kernohan, an economist at Royal London Asset Management. ``There is more than enough tightening already in the system to bring inflation down later next year.''
Barclays Capital and nine other banks and research groups changed their forecasts yesterday to predict a rate cut after evidence that higher lending rates are starting to affect the wider economy.
Service industries from banks to airlines grew at the slowest pace since May 2003, according to a survey of purchasing managers by the Chartered Institute of Purchasing and Supply. The figures cover two-fifths of the economy.
Mortgage rates are also rising even though the bank's benchmark rate has been unchanged for the past five months. HBOS Plc said house prices fell for a third month in November, the worst streak for property values since 1995, suggesting the decade-long housing boom is coming to an end.
``This cut should make it cheaper for people taking out a new mortgage or coming off existing fixed rate terms, and provide some support to the housing market,'' said Adrian Coles, director of the Building Societies Association. ``Activity in the housing market was already beginning to slow as a result of the previous increases in interest rates, and this is likely to continue.''
