Bank split over rate cut

The Bank of England's monetary policy committee (MPC) was split on this month's surprise decision to cut interest rates, it emerged today.

Minutes of the February 5 and 6 meeting showed that two members of the MPC, Andrew Large and Paul Tucker, wanted to hold rates steady at 4%. But they were outvoted by the other seven MPC members, including Sir Edward George, the bank's governor, and his designated successor, Mervyn King, who is considered a hardliner on inflation.

Bank minutes showed that most of the MPC are increasingly preoccupied by the weakening world economy and its impact on the UK. Minutes said that the UK economy was now expected to grow more slowly, partly reflecting the weaker world outlook, partly the effect of lower share prices and the less favourable outlook for investment, and to a lesser extent, consumption.

It was unclear whether weaker consumer sentiment and lower share prices reflected nervousness about the prospect of war in Iraq or more deep-seated economic weakness. But even if that nervousness was temporary, it might bring forward the expected slowdown in consumer spending.

The bank triggered alarm in the City earlier this month by cutting rates by 0.25% to 3.75%, with some economists calling the move a gamble, as it was unclear that house prices and consumer demand had really slowed down. Some analysts described the reasons for cutting rates as "flimsy".

"The reason the MPC expects weaker GDP growth in 2004 is because they expect consumer spending to slow under the weight of the increased debt burden," said John Butler, UK economist with HSBC. "Yet surely that risk is exacerbated rather than diminished by daring consumers into greater debt."

However, most MPC members said that there were indications that consumer demand was slowing and that house price inflation was beginning to ease. Mr King recently said that house price inflation was past its peak and was set to fall to zero in two years.

The bank's primary job is to set monetary policy so as to meet the Treasury inflation target of 2.5% - no more, no less. For most of the MPC, the bank's own inflation forecasts required an adjustment in interest rates to meet that target.

Although underlying inflation, which excludes volatile mortgage interest payments, was expected to rise in the coming months, the bank said this was due to temporary factors and felt that inflationary pressures might be weaker than projected.

As for concern over house prices, bank minutes said: "Some members argued that the current rapid pace of house price inflation was being driven more by the general expectation of a stable and growing economy than by the level of interest rates. The committee also doubted that the recent falls in share prices and in business and consumer sentiment would quickly be reversed, even if the current geopolitical uncertainties were resolved."

Mr Large and Mr Tucker, however, took a diametrically opposed view, arguing that "any signal of an easier rate environment could prompt further, unsustainable, accumulation of debt by households, potentially exacerbating the subsequent adjustment and complicating the operation of monetary policy."