Bank of England May Cut Benchmark Rate to Record Low

By Svenja O’Donnell and Brian Swint

Jan. 8 (Bloomberg) -- The Bank of England will probably cut the benchmark interest rate to the lowest ever today as officials move closer to the limits of conventional monetary policy to fight the recession.

The Monetary Policy Committee, led by Governor Mervyn King, will trim the bank rate by half a point to 1.5 percent, according to the median forecast of 60 economists surveyed by Bloomberg News. That would be the lowest since the central bank was founded in 1694 and the fourth reduction since the global coordinated emergency cuts on Oct. 8.

Chancellor of the Exchequer Alistair Darling says the U.K. Treasury will need to play a bigger role in setting monetary policy if rates approach zero. The pound dropped to a record low against the euro last week on speculation the central bank will keep cutting borrowing costs as the recession deepens, stoking unemployment. Options include injecting money into the economy and the financial system by buying assets, economists say.

“The outlook for the economy is pretty bleak and the first half will be horrible,” said Stewart Robertson, an economist at Aviva Investors Ltd. in London, which manages about $230 billion in assets. “Whether the trough is zero or half a point, it doesn’t really matter now. We’re moving towards more coordination between the Bank of England and the government.”

Any U.K. rate cut today would bring the benchmark to the lowest since King William III created the bank in the 17th century to fund a war with France. The European Central Bank has cut its key interest rate by 1.75 percentage points to 2.5 percent since early October, and may reduce it again next week.

President Jean-Claude Trichet will give a speech in Bratislava at 7 p.m. London time today.

Fed Action

U.S. Federal Reserve Chairman Ben S. Bernanke has already taken further steps to boost the economy. The Fed lowered the rate for overnight loans between banks to a target range of zero to 0.25 percent on Dec. 16 and said it would buy unlimited quantities of securities. Rates in Japan are also close to zero.

A U.K. policy of so-called quantitative easing may see Prime Minister Gordon Brown authorize the central bank to buy assets such as government bonds and create money to pay for them. That would come on top of last year’s 50-billion pound ($75 billion) rescue plan for banks.

“The closer interest rates come down to zero, the more the normal transmission mechanism and the operation of monetary policy has to be looked at,” Darling said in an interview with the Financial Times published yesterday. Brown has signaled that the government may be planning other steps to help businesses and consumers.

Lack of Ammunition

“The MPC is getting to the stage where it is almost running out of interest-rate ammo,” said Robin Marshall, director of fixed income in London at Smith & Williamson Investment Management. “We’re going to see quantitative easing and more bank recapitalizations. I can’t believe that what we’ve seen so far is sufficient to free up the banking system.”

Financial institutions are hoarding cash and a Bank of England survey last week showed they plan to constrict credit even further. Mortgage approvals dropped to the lowest level since at least 1999 in November.

U.K. services shrank at close to the fastest pace in at least a dozen years in December, a survey by the Chartered Institute of Purchasing and Supply showed this week. Nationwide Building Society said that house prices fell by the most since 1991 and consumer confidence dropped to the lowest in at least four years.

Inflation Forecast

The economy contracted 0.6 percent in the third quarter and may shrink further, prompting job losses. Unemployment rose at the fastest pace since 1991 in November and Marks & Spencer Group Plc, Britain’s largest clothing retailer, said yesterday it will cut 1,230 of its staff.

The recession has also eased price pressures. The inflation rate fell to 4.1 percent in November from 4.5 percent the previous month. King predicted on Dec. 16 that the rate may drop below the 1 percent lower limit this year.

Policy makers cut the benchmark interest rate by 1 percentage point in December, refraining from a bigger reduction because it may prompt an “excessive” drop in the pound. The currency reached 98 pence per euro for the first time on Dec. 30 and dropped 23 percent last year. It has since trimmed some of its losses and traded at 90.48 pence at 8:05 a.m. in London.

“The situation remains grim,” said Neil MacKinnon, chief economist at ECU Group Plc in London and a former U.K. Treasury official. “They’ve got to continue to cut rates aggressively. It’s entirely possible that they’ll announce something about quantitative easing in the statement. They might say they’re giving such measures consideration.”

To contact the reporters on this story: Svenja O’Donnell in London at sodonnell@bloomberg.net; Brian Swint in London at bswint@bloomberg.net.