Wednesday, November 19, 2008

BOE Saw Need for Rate Reduction of More Than 2 Points (Update2)

By Svenja O'Donnell

Nov. 19 (Bloomberg) -- Bank of England policy makers considered an even bigger reduction in the benchmark interest rate than the 1.5 percentage-point cut announced on Nov. 6 as their forecasts pointed to a deepening recession.

The possible need for a cut to less than 2.5 percent was discussed at the Monetary Policy Committee's meeting, according to minutes published today by the central bank in London. Governor Mervyn King and his colleagues vote 9-0 to lower the rate to 3 percent from 4.5 percent.

The U.K.'s inflation rate had the biggest drop in at least 11 years in October as the economy shrank, data showed yesterday. King said last week that Britain probably faces a recession and the central bank is ready to cut the interest rate as much as needed to prevent deflation from taking hold.

``The projections in the inflation report implied that a very significant reduction in bank rate -- possibly in excess of 200 basis points -- might be required in order to meet the inflation target in the medium term,'' the committee said.

Policy makers limited the reduction to 1.5 percentage points because they wanted to wait for details of government tax plans and see the effects of the state rescue of financial institutions.

Inflation Credibility

They also said that a bigger cut may surprise financial markets and damage the credibility of their inflation target. Some policy makers said that limiting the reduction gave room for further cuts to bolster confidence in future, the minutes showed.

``The facts have changed to such a degree that, not only did we require 150 basis points, but more is in the pipeline,'' said Philip Shaw, chief economist at Investec Securities in London. ``They clearly believe more aggressive action on interest rates is likely to be required.''

Consumer prices rose 4.5 percent from a year earlier, compared with 5.2 percent the previous month, the statistics office said yesterday. The slowing economy is fuelling concerns of deflation, as manufacturers' raw material costs and output prices fell at the fastest pace in 22 years last month.

Policy maker Timothy Besley said yesterday that the weakness of the pound, which has dropped more than 24 percent against the dollar this year, probably won't be enough to prevent inflation from slowing below the 2 percent target in 2009. The pound traded at $1.5006 as of 10:29 a.m. in London today.

``Inflation is likely to fall below target next year, notwithstanding upward pressure on inflation from the continued fall in the value of the pound,'' Besley said in a speech at the Royal Economic Society in London.

King said on Nov. 12 the bank is ``prepared to cut bank rate to whatever level is necessary,'' to keep inflation at the target and didn't rule out putting the benchmark at zero. The Bank of England's forecasts, published on Nov. 12, show inflation may slow ``well below'' the 2 percent goal in 2009.

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