Bank hints at more rate cuts

The Bank of England yesterday held out the prospect for further cuts in interest rates when it warned that the downturn in the United States could have knock-on effects on both growth and inflation in Britain.

In its latest quarterly inflation report, the Bank admitted that it would undershoot the government's 2.5% inflation target for a total of four years and that there was a chance that price pressures could turn out to be even weaker than it is anticipating.

The Bank said that last week's quarter-point reduction in base rates to 5.75% had been a pre-emptive strike, even though it believes that the UK economy is in reasonable shape.

However, the Bank added: "The risks to growth and inflation are presently clearly on the downside, stemming in particular from the risk of a deeper or more prolonged slowdown in the US."

The report revealed differences of opinion among the nine-strong monetary policy committee over the prospects for inflation, which has been below 2.5% since the spring of 1999 and is not projected to return to that level until 2003.

One faction on the committee believes that improvements to Britain's supply-side performance and the darkening global outlook mean that inflation could come in up to 0.5 percentage points lower than the Bank's central projection.

Another group is worried about the tightness of the labour market, a concern certain to be exacerbated by yesterday's figures from the office for national statistics showing a larger than expected increase in average earnings and a hefty fall in unemployment.

Data released on Tuesday showed that the government's preferred measure of inflation, which excludes mortgage interest payments, had fallen to a record low of 1.8%. If it should fall to 1.5%, Bank governor Sir Eddie George will be obliged to write a letter to the chancellor explaining what steps the MPC is taking to return inflation to its target. Mervyn King, the Bank's deputy governor, said yesterday that the main reason inflation had undershot its target was the strength of sterling, which the Bank had failed to predict. With interest changes taking time to work, he said there was no point in trying to create "an artificial boom" to make up the inflation shortfall, and then having to rein in the economy again.

He added that the imminence of a general election campaign would not deter the MPC from acting on rates in the coming months. "If we feel the need to make a change we shall do so. That's our remit."