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Britain's rate cut opens gulf with European Central Bank

Section: Daily Dispatches

By Chris Giles and Ralph Atkins
Financial Times, London
Thursday, December 6, 2007

A gulf opened up between Europe's two largest central banks on Thursday after the Bank of England responded to the global credit squeeze by cutting interest rates while the European Central Bank indicated another increase was still on the agenda.

The Bank of England cut its main interest rate by a quarter of a percentage point to 5.5 per cent, reflecting its concern that the medium-term economic outlook had darkened in recent weeks.

It blamed deteriorating conditions in financial markets and "a tightening in the supply of credit to households and businesses" that threatened to depress growth and allow inflation to fall too far below the Bank's 2 per cent target.

Although the Bank was still worried about inflation over the next few months, it judged that the risks to the wider economy justified easing monetary policy.

The Bank's analysis matched that of economists from the Organisation for Economic Co-operation and Development, who argued on Thursday that "the UK could be more vulnerable than most countries to the impact from financial turmoil and because of evidence that the housing market is turning sharply down."

A majority of 61 economists polled by Reuters predicted that rates would fall to 5 per cent by next summer.

Investors, however, preferred to hedge their bets, taking as much notice of the bank's continued worries about inflation.

The FTSE 100 index closed at 6,485.6, down 8.2 points on the day while money markets concluded that there was now a slightly lower chance that the Bank would cut rates below 5 per cent in a year’s time.

However, Jean-Claude Trichet, ECB president, said the impact on the real economy of the global credit squeeze remained unclear.

He said that the ECB had not jettisoned completely plans to raise interest rates from the current 4 per cent level, arguing after a meeting of the ECB's governing council that "some" members had favoured such a move.

The departure from the usual unanimity in ECB decision-making pointed to divisions among the governing council members.

But Mr Trichet's unexpectedly tough stance highlighted how far the Frankfurt-based institution remained from considering an interest rate cut -- even if some in financial markets dismissed his comments as bluster.

"This is a wake-up call that the ECB is not on the same page as the Bank of England and US Federal Reserve," said Ken Wattret, economist at BNP Paribas.

The ECB's confidence was also reflected in a relatively upbeat assessment of eurozone growth prospects. Although growth would moderate, "the fundamentals of the euro area remain sound," Mr Trichet said.

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