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British interest rates set to fall to all-time low

The Bank of England looks set to chop interest rates by at least half a%age point on Thursday to an historic low to try to prevent the British economy from falling into a deep and lasting downturn.

With economic recession a foregone conclusion, financial markets are almost evenly split between pricing in a rate cut of 50 or 75 basis points from the current 2%. Several analysts are expecting a reduction of a full percentage point.

Any cut, the fourth in as many months from a level of 5.0% in October, would take interest rates to their lowest level since the Bank was established in 1694. Even in the Great Depression of the 1930s, rates only got as low as 2%.

And the cuts will not end there. Another big reduction that could take interest rates below 1% looks a sure bet in February, alongside a signal that borrowing costs will stay low for long time to come.

Attention is shifting to what can be done once rate cutting is exhausted, a process known as quantitative easing.

A British government spokesman denied reports on Thursday that it was about to print more money to stimulate demand but said no options had been ruled out.

“The Chancellor is prepared to consider all options to achieve financial stability but reports that the government is about to print more cash are not accurate at this stage,” said a Treasury spokesman.

The government is also facing calls to extend loan guarantees to get credit flowing back through the economy.

The data has certainly been bleak. House prices have fallen 20% from their peak. Car sales have dived and many retailers are being forced out of business. More than 75,000 people signed up for unemployment benefit in November alone.

J. Sainsbury Plc, Britain's third-biggest supermarket chain, reported third-quarter sales at the top end of forecasts, helped by strong demand for its budget range products as consumers tighten their belts.

“The economic environment remains particularly challenging and we expect this to continue in 2009,” Sainsbury Chief Executive Justin King said in a statement.

A survey from Incomes Data Services, meanwhile, showed falling inflation was starting to nudge some wage deals lower.

“For most of its life, the Monetary Policy Committee has set interest rates as a trade-off between growth on the one hand and inflation on the other. Now, however, both are pointing in the same direction as the recession deepens and inflation collapses,” said Andrew Smith, chief economist at KPMG.

“Against this background, there is no reason not to keep cutting interest rates.”

Finance minister Alistair Darling signaled in a newspaper interview on Wednesday that he no longer expects a swift economic recovery in the second half of the year. Further tax cuts or government spending look likely in the March budget.

That still may not be enough to get the economy moving again as long as banks run scared of making any new lending. BoE policymakers have even been thinking of ways of boosting the economy through more unconventional means once interest rates cannot go any lower.

As interest rate heads towards zero, central banks around the world are having to consider the same kind of quantitative easing steps the Bank of Japan took earlier this decade.

“We are skeptical that QE in the strict sense, i.e. flooding the banking system with reserves, will give the real economy a significant push, especially as this did not appear to have a material effect in Japan,” said Philip Shaw, chief economist at Investec. (Reuters)