Bank plans lowest ever interest rate

THE Bank of England is tipped to slash interest rates by at least another 0.5% this week as the Government comes under renewed pressure to ensure cuts are passed on to cash-strapped businesses and households.

The Bank's Monetary Policy Committee (MPC) is expected to make a proactive start to 2009 by slashing rates to 1.5% on Thursday, marking the first time UK interest rates have fallen below 2% since the central bank was created in 1694.

But there is mounting dissatisfaction that lenders are failing to transfer the benefits of rate cuts to their customers after Nationwide Building Society stated on Friday it would not pass on any further reductions in the base rate to many of its mortgage customers.

Chancellor Alistair Darling also faces growing demands for urgent action on lending after a report on Friday showed banks have continued to reduce the availability of credit. It is understood Darling is considering pumping billions more into the banking system to kick-start lending.

To add to policymakers' woes, economists are already warning that a 0.5% cut in interest rates will not be enough to ward off the threat of deflation this year.

"We are in for a prolonged period of recession, but even more than that the main concern on the part of most economists is the possibility that inflation will morph into deflation," said Jeremy Batstone-Carr, head of private client research at Charles Stanley stockbrokers. "It's possible we might be in a period of deflation from the third quarter of this year."

Some in the City are calling on the Bank's governor Mervyn King and his colleagues to continue a programme of swathing cuts after they reduced rates by 1.5% in November and a further 1% in December.

But it is thought MPC members are anxious about the recent dramatic falls in the value of the pound and are likely to opt for a smaller reduction, allowing time for the effects of previous reductions to filter through to the wider economy.

Consensus in the City currently points to interest rates reaching a low of 1% this year, although Howard Archer, chief UK and European economist at Global Insight, said it is "far from inconceivable" that rates could hit 0%.

The pound, which lost a quarter of its value in 2008, took another hammering on Friday after the Bank of England's latest credit conditions survey showed lenders continued to rein in credit lines to businesses and households in the final three months of 2008.

It is understood the Government will decide "within weeks" whether to intervene in the banking sector again as evidence mounts that its £37bn bailout last October has failed to dramatically improve conditions.