BOE Cuts Rate to Lowest Since Bank’s Creation in 1694

By Svenja O’Donnell

Jan. 8 (Bloomberg) -- The Bank of England cut the benchmark interest rate to the lowest since the central bank was founded in 1694 as policy makers tried to prevent the credit squeeze from deepening Britain’s recession.

The Monetary Policy Committee, led by Governor Mervyn King, trimmed the bank rate by a half point to 1.5 percent. The result matched the median forecast of 60 economists in a Bloomberg News survey. The pound rose against the euro and the dollar.

“The availability of credit to both households and businesses has tightened further, pointing to the need for further measures to increase the flow of lending to the non- financial sector,” the Bank of England said in a statement. “Output is likely to continue to fall sharply during the first part of this year.”

The reduction limits the central bank’s scope to keep fighting the recession with its main policy tool. That may spur King to cooperate with Prime Minister Gordon Brown to inject money into the economy and the financial system through so- called quantitative easing.

“They’ll come down below 1 percent by the second quarter,” said Philip Shaw, chief economist at Investec Securities in London. “Things have deteriorated further and this highlights the need for further monetary stimulus. Quantitative easing or non-conventional monetary policy techniques are on the cards.”

Pound Rises

The pound rose as the Bank of England’s move dashed some investors’ expectations of a larger cut. The currency climbed as much as 1.3 percent against the euro after the decision and traded at 89.06 pence per euro as of 12:30 p.m. in London. Against the dollar, it increased 1.2 percent and traded at $1.5241.

The central bank reduced the interest rate by 1.5 percentage points in November and by 1 percentage point in December.

The Bank of England may soon have to join the U.S. Federal Reserve and the Bank of Japan in expanding its toolkit to fight the financial crisis.

U.S. officials, led by Fed Chairman Ben S. Bernanke, lowered their main interest rate close to zero in December and on Jan. 5 started buying mortgage-backed securities. Rates in Japan are also close to zero and the central bank has increased its emphasis on adding funds to the financial system.

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 may provide clues on his thinking when he gives a speech in Bratislava at 8 p.m. local time today.

Treasury Role

Chancellor of the Exchequer Alistair Darling told the Financial Times this week that the U.K. Treasury may need to play a bigger role in setting monetary policy if interest rates approach zero. That may prompt the government to authorize the central bank to buy assets including government securities and perhaps create money to pay for them.

Darling today tried to damp speculation the government is ready to create money as part of a quantitative easing policy.

“Nobody is talking about printing money,” he told broadcasters in Liverpool, northwest England, where Brown will hold his weekly Cabinet meeting later today.

Financial institutions are hoarding cash and a Bank of England survey last week showed they plan to constrict credit further even after the government unveiled a 50 billion-pound ($75 billion) rescue plan last year. Mortgage approvals dropped to the lowest level since at least 1999 in November.

Brown ‘Fighting’

“We are fighting to do the right things,” Brown said today in a speech in Liverpool, northwest England, where he is holding his weekly Cabinet meeting today. “The global banking system failed. We have got to rebuild it.”

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

“It’s baked in the cake that we’ve got higher unemployment coming, and that economic growth is likely to remain weak for a long time,” said George Buckley, chief U.K. economist at Deutsche Bank AG in London. “They can still cut further.”

Rate History

The benchmark rate has never been this low since King William III founded the central bank to fund a war against Louis XIV’s France. The rate began at 6 percent and fell no lower than 4 percent throughout the 18th century.

It touched 2 percent several times in the second half of the 19th century. The central bank held it at that level throughout World War II until 1951.

The economy contracted 0.6 percent in the third quarter and may shrink further, prompting job losses to spiral. Unemployment rose at the fastest pace since 1991 in November and a survey released yesterday by the Recruitment and Employment Confederation and KPMG showed the number of workers placed in permanent jobs fell at the fastest pace since 1997 last month.

Barclays Plc, the U.K.’s third-biggest bank, said yesterday it will cut 408 information-technology jobs, primarily in London and Cheshire, England. Marks & Spencer Group Plc, Britain’s largest clothing retailer, said it will cut 1,230 of its staff.

Easing price pressures are giving the Bank of England scope to keep cutting interest rates. Inflation slowed to 4.1 percent in November from 4.5 percent the previous month. King predicted on Dec. 16 that the rate of annual price increases may drop below the 1 percent lower limit this year.

The central bank 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.

“I’m not sure interest rates will necessarily get to zero,” said Matthew Sharratt, an economist at Bank of America Corp. in London. “We may see them at 0.5 percent by the end of the first quarter. But now it’s really about what they do about quantitative easing.”

To contact the reporter on this story: Svenja O’Donnell in London at sodonnell@bloomberg.net.