Bank of England cuts rates to 0.5 per cent

The Bank of England cut interest rates by 50 basis points to a record low of 0.5 per cent yesterday, and said it would pump £75 billion of new money into buying assets, mostly gilts, to combat the recession.

UK government bonds soared on the news the BoE would be starting so-called quantitative easing - effectively printing money - on such an aggressive scale over the next three months. The asset buying programme equates to around five per cent of GDP.

Doubts remain over whether it will work but the BoE may have had no choice - the economy shrank at its fastest pace in nearly three decades at the end of 2008, house prices are sinking at record rates and hundreds of thousands of jobs have disappeared.

"The world economy has turned down very rapidly since last autumn, the amount of money is not growing at all, and the economy is in a recession, so we need to increase the supply of money," BoE Governor Mervyn King said on Sky Television.

Mr King later yesterday said British interest rates are unlikely to fall any further, after the central bank cut borrowing costs to a record low of 0.5 per cent.

"I think its is very unlikely interest rates can go any lower," Mr King said in a television interview with Sky News. "It's practically as low as we think it's sensible to go. In order to increase the supply of money, which is our objective at present, we're now injecting money into the economy," he said. "We're very close to zero. What we're doing now is switching to injecting money into the economy directly."

The government set the BoE an overall limit of £150 billion for new money it can create, though 50 billion of this is money which had been previously earmarked for the Asset Purchase Facility but will now be unfunded.

Quantitative easing has previously only been tried in Japan in the early part of the decade with limited success. But it has now become a watchword for central banks everywhere as interest rates near zero in the most serious world downturn for decades.

The European Central Bank also cut interest rates by 50 basis points to a record low of 1.5 per cent yesterday. US interest rates are between 0 and 0.25 per cent and Japan's are at 0.1 per cent.

Economists said the BoE would stop at 0.5 per cent, after cutting by a total of 4.5 percentage points in six months, due to worries that very low rates could start having a counter-productive effect by hitting bank profits.

"We expect this to be the final reduction in policy rates, with Bank Rate maintained at this level for a considerable period," said Ross Walker, UK economist at RBS. "Overall, the scale and timing of the QE operations appears significant."

"The lasting benefits for credit availability and demand are much more uncertain but, given the severity of the macroeconomic and financial backdrop, it is worth a try."

The June gilt future settled 255 ticks higher on the day and yields on 10-year gilts fell 34 basis points, their steepest one-day fall in more than a decade, traders said. Sterling extended losses against the dollar, hitting a session low of $1.404.

The BoE said it would buy medium and long-dated gilts and kick off the process with £2 billion on March 11, targeting a variety of maturities so to not distort demand. Gilt issuance is already at a record £146.4 billion this year and could balloon further in the next financial year as the public finances are in really bad shape given the scale of the downturn.

The BoE said that even with the latest rate cut, there was a substantial risk of inflation undershooting the two per cent target in the medium-term.

"It is blatantly clear that the UK economy needs as much help as it can get, given that it remains mired in deep recession with credit conditions damagingly tight," said Howard Archer, UK economist at Global Insight.