Bank cuts rates by quarter point

The Bank of England today responded to the increasing clamour for lower rates from struggling manufacturers by cutting the cost of borrowing for the first time in over a year, to 3.75%.

In a move that surprised the City, the Bank's monetary policy committee (MPC) cut rates by 0.25% to 3.75%. The MPC last reduced rates in November 2001. The MPC said in a statement that the "prospects for demand, both globally and domestically, were somewhat weaker than previously anticipated". That would outweigh current upward pressures on inflation which were only temporary, it added.

But some analysts described the move as the biggest gamble taken by a central bank in years.

"The manufacturing and investment sectors are unlikely to benefit from this," said John Butler, UK economist with HSBC. "So the MPC thinking must be that they are still trying to offset this weakness through pushing up the consumer again! There is obviously a chance that the MPC may well get away with their balancing act but the risk of a housing market bubble and rising consumer indebtedness have now been exacerbated."

The Bank's decision followed the release of new economic data that once again underlined the two-speed nature of the UK economy.

The Confederation of British Industry (CBI) yesterday published its latest regional trends survey, showing that gloom within the manufacturing industry has spread to every region of the UK. Evidence is also emerging that the services sector is showing signs of weakness.

The Chartered Institute of Purchasing and Supply (CIPS) said activity in the services sector was expanding at its lowest rate for almost a year. CIPS' monthly services index slipped to 52.3 in January from 53.2 in December - (50 marks the dividing line between economic expansion and contraction) - its weakest reading since February last year.

Unions had warned that manufacturing jobs would be lost unless the Bank cut interest rates. The Amicus union said manufacturing was in recession and had suffered its biggest annual decline for a decade last year.

"Every time a job in manufacturing goes, there is a knock-on effect in terms of redundancies in the service sectors," Roger Lyons, the union's joint general secretary, said. "The interest rate is causing irreparable damage to our manufacturing industry."

The Engineering Employers' Federation (EEF), which has also been calling for lower rates, congratulated the bank for heeding the signs of manufacturing weakness.

"The warning signs are there for all to see. In the midst of such uncertainty manufacturers will breathe a sigh of relief that the MPC stands ready to do all it can to shelter the economy from the gathering storm clouds," said Stephen Radley, its chief economist.

Until now, the Bank has been reluctant to lower rates for fear of feeding the boom in house prices. Halifax yesterday reported a 1.5% monthly rise in the price of the average home, suggesting that the housing market remains buoyant. Despite concerns of a crash in house prices, Britain's biggest mortgage lender said all the evidence showed that the housing market remained in "very good shape".

For its part, the Bank has downplayed fears of a collapse in house prices and consumer demand by arguing that they are unlikely to occur as long as the jobs market remains strong and interest rates stay low. Some economists have argued that UK manufacturers would be better off with a boost in demand from the US and Europe rather than lower rates..

· The European Central Bank today kept eurozone interest rates on hold at 2.75% for the second successive month. The ECB last cut rates in December, by half a percentage point.

Economists are predicting another cut soon, due to the strong euro and the continent's sluggish economy. Yesterday Germany announced its unemployment had surged to a five-year high of 4.27m in January. The ECB is projecting economic growth of between 0.6% and 1% this year across the 12 nations that share the euro.

It said last month that "the current low level of interest rates should help to counterbalance" risks to Europe's economy from "geopolitical tensions" and rising oil prices - a reference to a possible war with Iraq. The rise of the euro against the dollar should help keep eurozone prices down, it added.