Bank of England cuts interest rates to record low

FRANKFURT - The European Central Bank halted its campaign of interest rate cuts Thursday, leaving its benchmark rate at two per cent while the Bank of England cut by a half-point to a record low one per cent as it tries to get the ailing British economy back on track.

The widely expected decisions by both banks marked their decidedly different approaches to the global economic woes that have sent financial markets plunging and led to thousands of layoffs, reduced worker hours and factory shutdowns across Europe.

The ECB, central bank for the 16 countries that use the euro with their 330 million residents and US$5.6 trillion economy, has been more cautious in cutting rates, which can stimulate growth by lowering borrowing costs for businesses and consumers but can stoke inflationary pressures.

Though both banks conceded that their economies are in the midst of their deepest recessions in decades -- Britain's 1.5 per cent contraction in the fourth quarter of 2008 was the worst since 1980 -- they sought to pierce the gloom by laying out the hope that the raft of policy measures since last fall will start to bear fruit some time this year.

While warning that coming fourth quarter growth figures for the euro zone will likely be "very negative" and that the weakness will continue into coming quarters, ECB President Jean-Claude Trichet said the single currency zone should start to "reap the benefits of significant policy measures."

And the Bank of England said it expected the sharp interest rate reductions enacted since October to have a "significant impact" on the economy eventually.

"Together with the recent easing in fiscal policy, the substantial fall in sterling and past falls in commodity prices, that would provide a considerable stimulus to activity as the year progressed," the bank said.

Since October, when the financial crisis sharpened, the European Central Bank has cut its benchmark rate from 4.25 per cent, while the Bank of England has slashed its rate from five per cent. In addition, both banks have flooded the financial markets with unprecedented amounts of money in the form of short-term credit to banks and efforts to reduce their holdings of shaky securities, while governments across Europe have loosened the purse strings.

Despite that relative optimism, both banks are expected to carry on cutting interest rates in the months ahead, though the European Central Bank may not go as far as the U.S. Federal Reserve and the Bank of Japan by pushing borrowing costs down to, or near, zero.

"Zero rate doesn't seem appropriate to us at this time," Trichet told the press briefing after the unanimous decision to keep rates on hold.

However, Trichet did indicate that another rate cut could be in the offing for March, and markets are pricing in a half-point cut.

"Two percent is not the lowest level we would have decided," he said.

Aurelio Maccario, an economist at UniCredit in Milan said Trichet's statement confirms that a half percentage point rate cut in March is "absolutely in the pipeline."

The Bank of England is expected to cut its main rate to, or close to, zero per cent, and has indicated that it may start to expand the money supply once interest rates fall to, or near, zero per cent to avoid a bout of deflation -- a corrosive spiral of falling prices.

"The Bank now has to act to avoid deflation without fear of a further weakening of sterling; a weaker currency should serve to add to the competitiveness of exports," said Hetal Mehta, senior economic adviser to the Ernst & Young ITEM Club.

Both central banks said inflation could fall to very low levels this year, though prices will likely remain volatile, amid sharply lower demand for goods and services and sliding energy and commodity prices. Lower inflation gives central banks more room to cut rates without fear of worsening prices rises.

Many economists have criticized the ECB for its relative caution, especially as inflation in the euro zone fell 1.1 per cent in the year to January -- below the ECB's mandate to target inflation "below, but close to two per cent.

"The ECB is clearly behind the curve, as it was in July 2008, when it raised interest rates by a quarter of a percent," said Richard Snook, senior economist at the Centre for Economic and Business Research.

"Global policy rates at zero and coordinated quantitative easing across all major economies is the best remedy for an unprecedented global crisis," he said.