BoE's surprise rate cut

August 2, 2001 Posted: 1328 GMT

LONDON (CNN) -- The Bank of England surprised markets Thursday with a cut in UK interest rates, but the European Central Bank held euro-zone rates steady.

The BoE cut rates by a quarter-point to 5 percent as economic slowdown triggered increasing numbers of job cuts. It has cut rates three previous times this year to try to cushion the UK against possible recession.

The ECB, as expected, kept its official rate at 4.5 percent, signalling that  the battle against inflation took priority over warding off the threat of economic slowdown.

Economists predict that the ECB will cut rates for the second time this year when it meets after its summer break on August 30.

"The ECB will come through with a cut, but it will wait to see what happens on the inflation front," Ben Rudd, market strategist at HSBC, told CNN before the decision. "They'll wait until this year's energy price increases come out of the (inflation) number, giving them leeway to cut rates."

Economists polled by CNN expected the Bank of England to hold off trimming rates until it had gathered more evidence about the outlook for consumer spending, which has remained buoyant despite widespread job cuts.

"Indicators of world economic activity have been weaker than expected over the past few months," the Bank of England said on Thursday.

"This and the persistent strength of sterling are adding to the pressures on the externally exposed sectors of the UK economy, and at the same time there are signs of weakening investment growth.

"By contrast, retail spending, household borrowing and the housing market are still robust, partly supported by recent reductions in interest rates. On balance, the outlook, although highly uncertain, is for aggregate demand and output growth to be weaker than previously projected."

Telecom equipment maker Marconi (MONI) and engineering giant Invensys (ISYS) are among the leading British companies to have announced staff reductions recently. 

The Monetary Policy Committee of the Bank of England, responsible for setting UK interest rates, has been confronted by a "two-speed" economy. Industry is calling for a rate cut but consumers remain upbeat for now.     

The Nationwide Building Society said house price inflation was running at an annual rate of 10.9 percent in July and there was "little evidence of a diminished appetite for housing."

The Confederation of British Industry said this week that in the month of July retail sales volume growth hit its quickest pace in more than a year, with a broad variety of shops enjoying a busy month. Unemployment is at its lowest level for 26 years.

However, many economists said the UK manufacturing sector was already in recession, and its decline was likely to have a knock-on effect on the service sector, as job cuts depress consumer confidence.

"The U.K. is sitting on the edge," said Ben Rudd, market strategist at HSBC. "The industrial sector is already in recession and that could feed through to the consumer side as job cuts filter through.".

Meantime, eurozone economic sentiment fell for the seventh month in a row in July, a survey by the European Commission showed on Thursday. The economic sentiment indicator, which is based on a survey of 25,000 consumers and 50,000 businesses, dropped to 100.6 in July from a revised 101.2 in June.

Some of the region's biggest companies have announced heavy job cuts in recent weeks, including telecom equipment maker Alcatel (PCGE), consumer electronics company Philips Electronics, German chipmaker Infineon Technologies (FIFX) and Swiss-Swedish engineering company ABB.

ECB President Wim Duisenberg has made it clear the central bank, which controls interest rates for the 12 nations that form the euro zone, would not move on rates until inflation slows.

The euro zone's harmonised rate slowed to 3.0 percent in June from a recent peak of 3.4 percent in May. The ECB has been mandated by its political masters to keep inflation below 2 percent.

Evidence is emerging that members of the euro zone are experiencing the ill effects of the U.S.-led slowdown.

French unemployment rose for the third consecutive month in June, pushing the headline jobless rate in the euro zone's second-largest economy up to 8.8 percent from an 18-year low of 8.7 percent previously.

On Friday, the French INSEE institute said French business confidence had fallen to its lowest level since April 1999.

The Munich-based Ifo institute called on the ECB to cut rates as it forecast that the German economy, Europe's largest, will expand just 1.2 percent this year, reducing its growth forecast from 2.2 percent previously.

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