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UK Rates Expected to Come Down Gradually

The Bank of England is widely expected to cut interest rates by 25 basis points Thursday, for the second time in three months, in a delicate balancing act between offsetting the impacts of a slowing economy and fending off inflation.

All of 60 economists surveyed by Reuters this week expected the central bank's Monetary Policy Committee to reduce rates by a quarter point to 5.25 percent, when they announce their decision at 12 pm London time.

The move is not likely to mark the end of the easing cycle, as the central bank will continue to cut throughout the year and reduce rates twice more before the end of August, George Johns, UK economist from Barclays Capital, told CNBC.com.

"The risks are very much on the downside, credit conditions are continuing to tighten," Johns said.

Fears over the strength of the economy have been intensifying ever since subprime losses and tightness in the credit markets sparked the near collapse of British bank Northern Rock last summer.

Clear signs of weakness in the UK commercial and residential property markets and slowing retail sales and services have all added to the Bank of England’s growth concerns.

But lower rates mean the softening pound is bringing higher import prices, which in turn aggravate inflation fears.

Gradual Response

Many economists consider the current economic slowdown to be different from the last recession in the early 1990s because of its seemingly gradual nature.

The Monetary Policy Committee will be reducing rates slowly to counteract the steady slowing of activity, according to Paul Dales, economist at Capital Economics.

The core interest rate could fall as low as 4 percent but that level won't be reached until sometime next year Dales told CNBC.com.

"The MPC is facing this dilemma of weakening activity on the one hand and rising price pressure on the other," Dales said.

The UK services sector remained well below its long-term trend in January with the Chartered Institute of Purchasing & Supply’s Index (CIPS/NTC) rising only slightly, which confirms the central bank’s need to cut by 25 basis to stimulate activity, Trevor Williams from Lloyds TSB Corporate Markets told "Worldwide Exchange" Tuesday.

But the output prices component of the survey came in at 55.3 for January, the highest level since March 2007.

"Inflation remains a concern in the UK," Williams said. "The Bank of England is not going to do a Fed and slash rates, they’re going to move very cautiously."

Contact Europe: Economy

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