MW: Bank of England signals it's prepared to cut again
Central bank slashes forecasts for inflation, economic growth
LONDON (MarketWatch) -- The Bank of England left little doubt Wednesday that it's ready to continue slashing interest rates as it wrestles with an economic recession and the threat of deflation, economists said after the central bank unveiled its quarterly inflation report.
The Bank of England shocked markets last week by slashing its key lending rate by 1.5 percentage points, down to 3%. The cut was the largest ever undertaken by the Monetary Policy Committee since it was formed in 1997.
"We are certainly prepared to cut that rate again if it is necessary," BOE Gov. Mervyn King said in a news conference unveiling the bank's latest inflation report.
Last week's cut left the official bank rate at its lowest level since 1955. See full story.
Asked to elaborate on the potential depth of future reductions, King said the BOE's Monetary Policy Committee was prepared to cut the bank rate "to whatever level is necessary" to ensure that inflation hits the 2% target.
Economists said further easing was virtually guaranteed.
More rate cuts "will indeed prove to be necessary, and we hold to our view that bank rate will fall to at least 2% by the summer, with the next cut expected in early 2009," said economist Peter Dixon at Commerzbank.
The scope for cuts below 2% depends on the evolving growth and inflation outlook, he said. Other economists see a more aggressive campaign, with the MPC expected to cut rates again in December.
In a further round of firsts, the November inflation report contains the largest-ever cut in the Monetary Policy Committee's inflation forecasts. The report warned that inflation was on track to slip well below 2% by 2010 if official rates follow the path currently implied by financial markets. Read the Inflation Report.
The remarks and the forecast sent the pound to another all-time low against the euro and to its lowest level against the U.S. dollar since 2002. Read Currencies.
"As we expected, the inflation report has effectively closed the door on the high-yielding pound era," said Stephen Gallo, head of market analysis at Schneider Foreign Exchange.
In his remarks, King said Bank of England officials couldn't rule out the possibility of deflation, but the report noted that the risk of a period of broadly falling prices remained small.
"In the central projection, inflation falls back sharply from its current high level in the near term, as the contribution from energy and food prices declines steeply," the report said. "Further out, inflation falls well below the 2% target, reflecting a larger margin of spare capacity and the waning impact on import prices from the lower level of sterling."
The projections show inflation falling below 2% in 2009 if the key rate is left at its current level of 3%, dipping below 1% by 2010. The BOE governor is required to write a letter to the chancellor of exchequer, Britain's finance minister, if inflation overshoots or undershoots the target by more than a full percentage point.
King has been required to write letters to the chancellor, Alistair Darling, this year as inflation surged -- likely peaking above 5% -- in response to soaring fuel and food prices.
Inflation pressures previously kept the Bank of England on the sidelines. But expectations for a sharp fall in price pressures as a global slowdown takes hold leave room for policy makers to make up lost ground, economists said.
"Basically, today's inflation report is a courageous acknowledgment that [the MPC is] definitely behind the curve and quick action is definitely needed," said Chiara Corsa, an economist at UniCredit MIB in Milan.
"The need to boost confidence at the current juncture is another additional reason in favor of further decisive and quick action. There is no room to wait," Corsa said.
The economist remains of the view that the Monetary Policy Committee will cut the key rate by another percentage point, to 2%, in December, and then ease it to 1.5% in January.
Echoing remarks by King last month, the Bank of England's report says the British economy likely entered recession in the second half of this year.
The economic projections, however, factor in a "substantial" degree of stimulus from cuts assumed in the Bank of England's lending rate, a gradual expansion in credit supply following efforts to recapitalize trouble banks, lower world energy and food prices, and a weaker British pound.
The Bank of England laid out a pair of scenarios about what the future may hold for the U.K. economy.
"The slowdown may be deeper and longer lasting, if the supply of money and credit tightens further at home and abroad, if households and companies have to make bigger balance-sheet adjustments, or if there is a larger shake-out in the labor market," the report noted.
On the other hand, the slowdown may be muted if bank lending and money markets recover more rapidly or if the government provides a strong fiscal boost to the economy, the report said.
The government is expected to outline tax cuts next week at its pre-budget address.
