Bank of England May Cut Interest Rate a Quarter Point to 5.25%

By Jennifer Ryan

Feb. 4 (Bloomberg) -- The Bank of England will probably cut its key interest rate for the second time in three months this week, setting aside concern that inflation will accelerate as economic growth slows, a survey showed.

The nine-member Monetary Policy Committee will lower the rate by a quarter point to 5.25 percent on Feb. 7, according to 58 of the 61 economists in a Bloomberg News survey. Two expect a half-point cut and one forecasts no change.

Falling house prices and higher market lending rates have put the U.K. economy on course for its worst performance since the end of the last recession in 1992. At the same time, Governor Mervyn King has indicated inflation pressures will keep the bank from following the Federal Reserve and slashing rates further in coming months.

``There is clearly a sense at the bank that rates are restrictive and need to come down,'' said Matthew Sharratt, an economist at Bank of America Corp. in London. ``Worries about inflation mean there won't be the same kind of aggressive easing as we've been seeing from the Fed.''

King, reappointed by Prime Minister Gordon Brown on Jan. 30, says the Bank of England faces a ``difficult balancing act'' in 2008. House prices fell the most since 2000 in the fourth quarter, mortgage approvals dropped to a nine-year low and the threat of a U.S. recession is dragging down global growth prospects.

U.K. manufacturing expanded at the slowest pace in more than two years last month, a survey by the Chartered Institute of Purchasing and Supply showed.

Constraints

Growth is slowing as pricing pressures increase. King said Jan. 22 that oil and food prices may drive inflation above 3 percent this year from 2.1 percent in December, matching the fastest pace in a decade. Consumers' inflation expectations for the next 12 months jumped to the highest since at least 2005, a report commissioned by Citigroup Inc. showed.

``There are constraints on how many reductions they can make,'' said Alan Castle, an economist at Lehman Brothers Holdings Inc. in London.

The Bank of England has been slower than the Fed in cutting rates. The Fed has reduced its benchmark by one-and-a-quarter percentage points since Jan. 22, its fastest easing of policy since 1990, after banks including Goldman Sachs Group Inc. and Citigroup Inc. forecast the first U.S. recession since 2001 and global equity markets tumbled.

The slowdown was sparked by a slump in U.S. house prices that's forced banks worldwide to post more than $133 billion in asset writedowns and credit losses. The U.S. economy unexpectedly lost jobs in January for the first time in more than four years, the Labor Department said Feb. 1.

`Relatively Soft'

Some economists say contagion from the U.S. slowdown will force the Bank of England to ignore inflation risks again and cut rates further after next week's move.

``Economic growth and expectations of growth are relatively soft,'' said George Buckley, an economist at Deutsche Bank AG in London. ``We see a cut at the next meeting and then another in April or May. The risks are that they move earlier.''

The Bank of England will reduce its benchmark to 4.5 percent by the end of the year, according to the median forecast of 44 economists in a Bloomberg News survey.

King says the circumstances are presenting the bank with its biggest dilemma since it was given rate-setting independence in 1997. The bank will probably have to write at least one letter to Chancellor of the Exchequer Alistair Darling this year explaining why it can't keep inflation below the government's 3 percent limit, he says.

``It will be harder this time for the bank to be confident that inflation will fall back to target,'' said Castle. ``But if growth deteriorates further, we'll see deeper rate cuts.''