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Bank of England reduces key rate to 5%

The Bank of England's Monetary Policy Committee has voted to reduce the official base rate paid on commercial bank reserves by 0.25 percentage points to 5%.

Consumer price index (CPI) inflation rose to 2.5% in February 2008. The committee expects inflation to rise further this year, reflecting the continuing impact of higher energy and food prices, as well as the recent depreciation of sterling on import costs. Such pressures are already evident in producer input costs and pricing intentions.

On the upside, above-target inflation this year could raise inflation expectations so that, in the absence of some margin of spare capacity, inflation would remain above the target. On the downside, the disruption in financial markets could lead to a slowdown in the economy that was sufficiently sharp to pull inflation below the target.

In the committee’s judgement, the balance of these risks to the inflation outlook in the medium term justifies a cut in bank rate this month. Credit conditions have tightened and the availability of credit appears to be worsening.

While the recent depreciation in sterling will support net exports, the prospects for output growth abroad have deteriorated. In the UK, business surveys suggest that growth has begun to moderate and that a margin of spare capacity will emerge during this year. This should help to keep domestic inflationary pressures in check in the medium term.

Against that background, the committee judged that a reduction in bank rate of 0.25 percentage points to 5% was necessary to meet the 2% target for CPI inflation in the medium term.