LONDON (MarketWatch) -- They're all Blanchflowerians now.
For months, economist David Blanchflower fruitlessly urged fellow members of the Bank of England's rate-setting Monetary Policy Committee to aggressively cut rates.
Failure to do so, he warned, ran the risk of allowing a burst housing bubble and global slowdown to drag inflation well below the central bank's 2% annual target - ensuring a potentially long and deep recession. See archived story.
But after cutting rates three times between December and April, the majority of the MPC opted to stay on the sidelines. In a policy dilemma, the MPC repeatedly left the key lending rate on hold at 5% as it balanced signs of a slowing economy with surging inflation pressures and, more importantly, rising inflation expectations.
The tide turned in October, when the MPC, just ahead of its regularly-scheduled monthly meeting, voted unanimously to join other major central banks in a coordinated rate move, dropping its key lending rate a half point to 4.5%. See full story.
Surveys show most economists expect the MPC to cut by at least another 50 basis points on Thursday when it announces its decision at noon local time, or 7 a.m. Eastern. Several economists expect policy makers to vote for a rate cut of a full percentage point, taking the lending rate down to 3.5%. They're expected to keep cutting aggressively well into next year.
Although the MPC has never before cut by more than 50 basis points, "the economic and financial crisis is unusually severe," wrote Michael Saunders, economist at Citigroup, in a weekly research note.
Data last month showed the U.K. economy shrank by 0.5% in the third quarter, following flat activity in the second quarter. The contraction was much sharper than expected.
And data so far, including manufacturing and service sector activity, consumer sentiment, unemployment and the housing market, all point to an even more dire outcome for the fourth quarter, said Howard Archer, chief U.K. and European economist at IHS Global Insight.
Archer has penciled in a half-point cut Thursday, followed by further half-point reduction in December, but said there is "a strong case for the MPC to be bold and cut interest rates from 4.5% to 3.5% in one move on Thursday.
The general public's inflation expectations, which had held most of the MPC at bay since April, are receding fast as the global economic outlook deteriorates.
That confirms that medium-term upside inflation risks are receding fast, likely leaving policy makers "ready to ease at an unprecedented pace unless worries about currency weakness and the ballooning fiscal deficit dominate," Saunders said.
ECB set to cut as well
It's likely to be a similar scene in Frankfurt, where the European Central Bank's Governing Council meets Thursday.
Again, economists expect the ECB to cut its key rate by 50 basis points, to 3.25%, when the central bank announces its decision at 1:45 p.m. Central European time, or 7:45 a.m. Eastern.
Strategists at BNP Paribas said markets will be looking for more than rate moves from central banks, particularly the ECB, given ongoing worries about European exposure to fragile economies in Central and Eastern Europe.
If the ECB's rate decision is accompanied with a move to provide countries in the region with swap facilities aimed at easing liquidity shortages, "there will be a significant impact on risk appetite," they wrote.
If central banks don't provide swap facilities, support for equity markets is likely to be relatively muted, they said, and could spell the end of a corrective bounce by the euro and the pound versus the U.S. dollar.
The ECB, whose sole mandate is to ensure price stability, had been even more alarmed about inflation threats. The central bank hiked its key lending rate as recently as July in an effort to anchor inflation expectations and to fire a warning shot to wage negotiators seeking to index future pay increases to the inflation rate.
The ECB, to the surprise of some economists, joined the BOE, U.S. Federal Reserve and other central banks Oct. 8 - cutting its key lending rate a half point to 3.75%.
A further half-point cut is seen as likely on Thursday, taking the rate down to 3.25%.
"Inflation is now very much yesterday's threat, and the ECB is only too well aware that extended, deep recession is now the major danger facing the euro-zone economies," Archer wrote in a weekly research brief.
Consumer inflation in the 15-nation euro zone slowed to a 3.2% annual pace in October, according to a preliminary estimate by Eurostat, down from 3.6% in September.
While still well above the ECB's target of near but just below 2%, economists expect inflation to fall rapidly toward the target in coming months as the economic slowdown takes hold.
Euro-zone data and surveys indicate the financial crisis is already weighing on activity, "significantly intensifying the danger of deep, extended recession," he said.
ECB President Jean-Claude Trichet last week signaled that the Governing Council was likely to follow through with a rate cut. Although he offered the caveat that policy makers would need to be convinced of further improvement in the inflation outlook, it's unlikely "he will disappoint market expectations of a 50 basis point reduction," said Jennifer McKeown, European economist at Capital Economics, in a research note. See related story.
She expects the ECB to cut by a further half-point in December, with the official rate falling all the way to 1.5% in 2009.
While that might seem like a "pretty aggressive' call for the ECB, McKeown notes the central bank cut rates aggressively to 2% in 2003 in the last economic downturn and left them there for two years.
"Admittedly, inflation is starting from a higher rate than it was back then, but it looks set to fall very sharply," she said. "What's more, we expect the economic slowdown to be much more severe than the one that occurred between 2001 and 2003, resulting in far greater spare capacity in the economy."
