Bank backs up its rate cut with bleak economic picture

The Bank of England today justified its half-point interest rate cut to 1% by warning that the British economy would keep declining sharply in the coming months.

Having seen UK output fall by 1.5% in the final three months of last year, the Bank warned of "a similar rate of decline in the early part of this year".

The International Monetary Fund recently warned Britain faces the worst downturn of any major economy.

The Bank said: "The underlying picture for consumer spending appears weak.

"Businesses have responded to the worsening outlook by running down inventories, cutting production, scaling back investment plans and shedding labour."

It admitted that past rate cuts have not had as much effect as they would have done in less turbulent times but added that they "would in due course" have a "significant impact".

Along with recent tax cuts, the fall in sterling, and lower commodity prices, the rate cuts would "provide a considerable stimulus to activity as the year progressed", it said.

However, policymakers also argued that inflation would fall rapidly from the current level of 3.1% and there was "a substantial risk of undershooting" the 2% target.

With the threat of deflation rising, the Bank said today's rate cut was therefore still necessary.

Its actions were not matched by the European Central Bank which, despite the agonies being felt by the crippled Spanish, Portuguese and Irish economies, opted to keep interest rates on hold at 2% after four reductions since October.

The Bank of England has slashed rates from 5% since October. Economists were unsure about its next move.

Ross Walker of Royal Bank of Scotland predicted "further moderation in the pace of monetary easing" in the UK in the coming months. "This could either take the form of skipping a month or, more likely in our view, a move to 0.75% in March and 0.5% in April," he said.

The Bank looks set to turn its attention to quantitative easing — printing money — although it today went no further than welcoming Government moves to set up an asset purchase facility to buy corporate debt.

The Bank said: "The global economy is in the throes of a severe and synchronised downturn.

"The weakness of the global banking and financial system means that the supply of credit remains constrained."