Bank of England signals it will cut interest rates

Reuters, London, Wednesday, November 14, 2007

British interest rates will need to fall in the next few months, the Bank of England signaled Wednesday, as it predicted a worsening outlook for both economic growth and inflation.

In the quarterly Inflation Report, the central bank's first formal look at the economic impact of the credit crunch, it said growth would slow sharply to just over 2 percent next year even if its main rate fell from 5.75 percent.

Price pressures were stronger because of soaring energy prices and a falling pound against the euro, putting inflation above the 2 percent target for most of next year before settling back in the middle of 2009.

"The near-term outlook is less benign for both inflation and growth," the bank's governor, Mervyn King, told a news conference, warning that more disruption in financial markets posed the biggest risk and stock markets around the world could still fall.

Experts took this as a sure sign the Bank of England would soon follow the U.S. Federal Reserve in lowering interest rates because of the credit squeeze this summer, as its forecasts assumed a rate cut to 5.5 percent early next year and another later in 2008.

"Crucially, the BoE has validated expectations that we are going to see two or three interest rate cuts in 2008," said Alan Clarke, economist at BNP Paribas.

The pound fell to a four-year low against the euro and interest rate futures rocketed higher as dealers ratcheted up bets of monetary easing in the months ahead.

King said everything now would depend on the data. The Monetary Policy Committee had left interest rates at 5.75 percent last week because inflation was rising and it was still unsure whether the economy was set to slow more than it had envisaged in August, he said.

King refused to take specific questions on Northern Rock, the mortgage lender that suffered Britain's first bank run in more than a 100 years in September, and said he had never considered resigning because of the crisis.

But people wondering whether he will win a second term as governor when his term expires in June 2008 will have to wait until next year, as King said he had concentrated on much more important things.

King warned that financial market disruption probably had several more months to run. But most British banks should easily be able to withstand losses arising from investments in the subprime U.S. mortgage market, he said.

"I would urge everyone to see the losses in the context of past profits and the capital cushion of the banks," King said. He added that "the big five banks" have made about £100 billion, or $205 billion in profits, "over the past few years."

Just what would happen to the global economy remained a big uncertainty though, particularly if stock prices fell. King warned that they were still soaring, seemingly ignoring the repricing of risk in many other markets. "There must be some downside risks there," he said.

Surging oil prices posed an upside risk to inflation but King showed little concern that the dollar was trading at 26-year lows against the pound and at record lows versus the euro.

This was part of a rebalancing of the global economy, he said, noting that the pound had been falling against currencies other than the dollar, which could eventually help Britain's trade performance. Still, global tensions over currencies were rising, he said, and would be a subject of discussion at the meeting this weekend of G20 policy makers in South Africa.

Euro-zone growth surprising

Euro-zone growth rebounded more strongly than expected in the third quarter thanks to its three biggest economies, data showed Wednesday, Reuters reported from Brussels. But economists said a looming slowdown would help keep European Central Bank interest rates on hold.

The European Union statistics office said gross domestic product in the 13 countries using the euro rose 0.7 percent in the July-September period from a year earlier, compared with a 0.3 percent increase in the previous three months.

"This is backwards-looking data," said Ken Wattret, economist at BNP Paribas. "Forward-looking indicators tell us that the economy will look in a much worse condition from Q4 onwards."