King Says BOE Prepared to Cut Rates as Low as Needed

By John Fraher and Jennifer Ryan

Nov. 12 (Bloomberg) -- Bank of England Governor Mervyn King said policy makers are prepared to reduce interest rates as low as needed to prevent a recession from fueling deflationary pressures.

Asked whether he would take rates to zero, King said today policy makers ``are prepared to cut bank rate to whatever level is necessary'' to make sure inflation hits the central bank's target. The Bank of England's forecasts, published today, said inflation may slow ``well below'' their 2 percent goal in 2009.

The pound dropped to a record low against the euro after King today forecast a deepening recession. The bank has already trimmed the benchmark rate twice in the last month, reducing it by 1 1/2 percentage points last week to a five-decade low of 3 percent.

The downturn has worsened in the past month, reports show. Unemployment rose at the fastest pace in 16 years in October, house prices are falling the most in a quarter century and manufacturing is in its worst recession since the early 1980s. Until last week, the central bank's benchmark was the highest among the Group of Seven nations.

``Today's inflation report is a courageous acknowledgment that they are definitely behind the curve and quick action is definitely needed,'' said Chiara Corsa, an economist at UniCredit MIB. ``Risks of a deflation scenario loom at the horizon.''

Pound Decline

The pound dropped to 82.38 pence per euro, extending its decline this year to 10 percent. Against the dollar, it dropped to the lowest since August 2002, falling to $1.5201 and has lost a quarter of its value since January.

The deterioration in the U.K. currency can be ``a helpful part of the rebalancing, provided it doesn't affect our ability to meet the inflation target,'' King said. The bank has ``no wish to see it fall very sharply.''

The Bank of England's key rate is now the second-highest among the Group of Seven nations. The Federal Reserve last month lowered its main rate to 1 percent, matching the lowest in a half century, and this month the European Central Bank cut its benchmark by a half point to 3.25 percent.

The Bank of England's forecasts show the U.K. economy will contract through 2009 and inflation will slow below the government's 1 percent minimum unless it cuts rates further.

Deflation Concern

Slowing growth and falling commodity prices are sparking concerns that inflation could give way to deflationary pressures. U.K. manufacturers' raw material costs and output prices fell at the fastest pace in 22 years in October, the Office for National Statistics said Nov. 10.

The central bank's forecasts, presented as fan charts, show deflation has slipped into the range of possible outcomes over the next three years and King conceded there's a ``risk'' that consumer prices will start to fall. The bank's central forecast is still for an inflation rate just over 1 percent, based on market interest rate expectations.

The Bank of England tries to hit a central inflation target of 2 percent and is obliged to keep it within a range of 1 to 3 percent.

Today's report prompted some banks to lower forecasts for the benchmark U.K. interest rate. Barclays Capital and BNP Paribas forecast a 1 percentage-point reduction at the December decision, compared with an earlier prediction for a half-point cut.

King, fielding criticism that he underestimated the risks facing the economy, said ``the world has changed'' since the collapse of Lehman Brothers Holdings Inc. in September.

``We have seen the biggest banking crisis since the outbreak for the First World War and arguably even bigger than that,'' he said. The forecast revisions are the largest the Bank of England has made since gaining rate-setting authority in 1997.

In a television interview pooled among broadcasters, King said that while the U.K. faces ``unprecedented times,'' the economy may improve as soon as next year.

``I think 2009 will be a difficult year but I would hope that by the end of that we would start to see clear signs of improvement,'' he said.

``When the facts change, then we'll change bank rate,'' King said. ``That's what we've done, and we're ready to do it again.''

To contact the reporters on this story: John Fraher in London at jfraher@bloomberg.net; Jennifer Ryan in London at Jryan13@bloomberg.net.