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The Bank of England sent out a clear message yesterday that interest rates would be cut again next month when it revealed that the monetary policy committee considered reducing borrowing costs by more than the 1.5 percentage points it announced this month.
Minutes of the MPC's November meeting showed that Threadneedle Street believed "a very significant reduction in [the] bank rate - possibly in excess of two percentage points - might be required" to prevent inflation falling below the government's 2% inflation target.
The doveish tone of the MPC minutes, coupled with a warning from the CBI that factories expect to cut output over the next four months at a rate not seen since the early 1980s, left the City convinced that interest rates would be cut by at least 0.5 point from 3% next month. City economists think that the bank rate may even come down to 2% - equalling the lowest it has been in the Bank's 314-year history.
In deciding unanimously for a 1.5 percentage point cut, the Bank said it wanted to see the size of Alistair Darling's tax and spending boost to the economy in next week's pre-budget report before assessing the required scale of further easing of monetary policy. The MPC also said it wanted to see whether October's coordinated efforts to shore up the banking system had increased the flow of credit and was concerned that a bigger reduction in the bank rate would scare the City. "Too large a surprise could pose upside risks to the inflation target if the resulting depreciation of sterling was excessive."
Apart from the emergency cut in interest rates on the day after Black Wednesday in September 1992, this month's move was the most aggressive since the early 1980s. The minutes revealed that the MPC was concerned the markets would think it had gone soft on inflation and wanted to leave some of the easing of policy until after it had had the chance to explain its view that the financial turmoil this autumn had markedly changed the outlook for prices.
Some MPC members also thought there was an argument for the Bank reserving some of its fire power so that it would be able in "the months ahead to support confidence as the economy weakened".
David Kern, chief economist at the British Chambers of Commerce, said: "The latest MPC minutes confirm a radical change in attitude. As demand prospects in the economy have deteriorated and inflation is set to plunge well below target, the MPC correctly acknowledge the need for sharp interest rate cuts.
"Businesses are now facing acute pressures in the face of a worsening recession. We urge the MPC to persevere with a forceful line, and cut rates to 2.5% in December," he said.
The CBI's monthly snapshot of industry showed that manufacturers are planning to retrench after seeing demand plummet. Seeing no positive effects from the recent sharp depreciation in the value of the pound, firms said the weakness of domestic and export order books was forcing them to plan production cuts.
Capital Economics, a forecasting and consultancy firm, said that if the survey was accurate there was a risk of a double-digit fall in manufacturing output next year - in line with the drop seen in the deep recession of 1974-75.
The CBI found that only 14% of firms expected to raise output over the next four months, while 56% planned to cut production. That left a balance of -42 points, the lowest since 1980. Order books edged up slightly from October but remained at their weakest for five years. Companies have also amassed large stockpiles of unsold goods, with a balance of +25 points reporting that their inventories were more than adequate to meet expected demand.
"The survey provides yet more evidence that the downturn in activity is not confined to the financial, construction and retail sectors," said Paul Dales, UK analyst at Capital Economics. He added that the forecast for factory production was "consistent with output falling by around 10% per annum compared to the current rate of decline of 2%. This would be a larger drop than the 7% drop seen in the early 1990s and similar to the 12% drop in the 1974-75 recession."
The biggest post-war slump in manufacturing occurred in 1980 and 1981, when output fell by about 25%.
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