LONDON (Reuters) - Interest rates will need to fall in the next few months, the Bank of England signalled on 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 the current 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,” 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 would soon follow the U.S. Federal Reserve in lowering interest rates because of this summer’s credit squeeze, as its forecasts assume 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.
A Reuters poll taken after the report was published showed 44 out of 51 economists now expect at least one rate cut by the first quarter of 2008. Most see a further cut by mid-year. Six say the first cut will come as early as December.
King said everything now would depend on the data. The Monetary Policy Committee had left interest rates unchanged 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 which suffered Britain’s first bank run in more than a century in September, and said he had never considered resigning because of the crisis.
He said he had much more important things to concentrate on than whether he would win a second term as governor when his term expires in June 2008, adding the question could wait until the new year.
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. The big five banks have made over the past few years about 100 billion pounds of profits,” he said.
Just what would happen to the global economy remained a big uncertainty though, particularly if share prices fell. King warned that stock investors were still seemingly ignoring the re-pricing 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 sterling and at record lows versus the euro.
This was part of a rebalancing of the global economy, he said, noting the pound had been falling against currencies other than the dollar, which could eventually help trade performance.
Still, global tensions over currencies were rising, he said, and would be a subject of discussion at this weekend’s meeting of G20 policymakers in South Africa.
Reporting by Sumeet Desai; Additional reporting by Fiona Shaikh, Matt Falloon, Paul Majendie, Sarah Marsh and Jonathan Cable; Editing by Ruth Pitchford