Dec. 6 (Bloomberg) -- The Bank of England cut its benchmark interest rate for the first time in two years, casting aside inflation concerns as the surging cost of credit threatens to derail economic growth.

The nine-member Monetary Policy Committee, led by Governor Mervyn King, reduced the bank rate by a quarter-point to 5.5 percent. The central bank said in a statement that ``conditions in financial markets have deteriorated,'' adding to ``downside risks'' to consumer prices and the economy.

The decision came only a week after King expressed concern that the outlook for consumer prices has become ``less benign.'' European Central Bank President Jean-Claude Trichet sounded the opposite note to the Bank of England today, telling reporters in Frankfurt that some policy makers discussed raising interest rates before deciding on no change.

The slowest services growth in four years and surging money market rates led Bank of England policy makers to set aside concerns about faster inflation expressed just last week by King. With consumer confidence at its lowest since 2004, banks including Morgan Stanley say house prices may decline next year.

``This is likely to be the first of several rate cuts,'' said James Knightley, an economist at ING Financial Markets, who changed his forecast yesterday and predicted a reduction.

Only 28 of the 62 economists in a survey by Bloomberg News predicted today's reduction. The analysts were the most divided since June 2004.

Pound Falls

The pound fell to near a 2 1/2-month low against the dollar after the decision. It touched $2.0254 by 4:01 p.m. in London, compared with $2.0266 yesterday. The U.K. currency also traded at 72.220 pence per euro, from 72.11 pence yesterday, when it was the least since May 2003. Bonds fell, pushing up the yield on two-year gilts by 8 basis points to 4.528 percent.

Royal Bank of Scotland Group Plc, UBS AG and Bank of America Corp. economists lowered their forecast for the benchmark U.K. interest rate after the decision.

``We continue to expect sizeable easing in the year ahead,'' said Michael Saunders, an economist at Citigroup Inc. ``Our base case is for rates to fall by a further 50 basis points. But the outlook is exceptionally fluid, and risks are on the side of greater easing over time.''

ECB Decision

The U.K.'s benchmark is still the highest among the Group of Seven industrialized nations. The U.S. Federal Reserve twice has trimmed its key rate, now at 4.5 percent. At the ECB, Trichet said ``some'' policy makers supported raising its rate from the current level of 4 percent.

There is ``strong short-term upward pressure on inflation,'' Trichet said at a press conference. The ECB ``stands ready to counter upside risks to price stability. We will not tolerate second-round effects'' on inflation.

King signaled the bank was planning rate reductions last month when he forecast the economy would slow ``sharply'' in 2008 after expanding more than 3 percent this year.

``Although upside risks to inflation remain, which the committee will continue to monitor carefully, slowing demand growth should ease the pressures on supply capacity, bringing inflation back to target in the medium term,'' the bank said in its statement.

Brown's Woes

Slower growth adds to the woes faced by Prime Minister Gordon Brown as he attempts to revive the Labour government's popularity, which touched a 19-year low last month, according to pollster ComRes.

Opposition lawmakers have criticized Brown, who served as finance minister for a decade before taking over from Tony Blair in June, for encouraging consumers to rack up a record debt burden, which fueled a tripling of house prices since 1997.

``We think the government should have done far more to prepare the economy for its current difficulties,'' Conservative leader David Cameron said in response to a question at a press conference. ``The government has not done enough to encourage competitiveness.''

Brown signaled his backing for the bank's decision.

``As chancellor and as prime minister, he is always being prepared to back whatever decisions the MPC thinks it is appropriate to make but those are decisions for them,'' Brown's spokesman, Michael Ellam, said at his daily briefing shortly before the decision was announced.

Cheaper Mortgages

For homeowners, each quarter-point cut in the central bank's benchmark rate shaves about 2.4 percent off monthly repayments on a standard mortgage of 200,000 pounds ($405,000), according to the Council of Mortgage Lenders. The payment would drop by 30.84 pounds per month to 1,275 pounds.

``A reduction in interest rates is exactly what the market needs and will benefit consumers,'' CML Director General Michael Coogan said. ``This will reduce the risk of payment shock for the 1.4 million borrowers coming off fixed rates in the next year.''

The impact of the subprime collapse, which caused lending between banks to seize up, is intensifying as institutions hoard cash to ensure they meet end-of-year funding requirements. The three-month Libor rate, a measure of borrowing costs for banks, was 6.64 percent today, near the highest since Sept. 18.

The Bank of England loaned 10 billion pounds for five weeks as it provided commercial banks with extra cash to help fund them until January. It allocated 16.1 percent of the total 62.2 billion pounds in bids after the rate decision. It also loaned 8.7 billion pounds in a one-week money-market auction.

`Squeeze Has Intensified'

``The credit squeeze has intensified,'' said Philip Shaw, an economist at Investec Securities in London, before today's rate decision. ``It's going to take longer for the money markets to return to normal than people thought a month ago.''

Higher money market rates sparked a run on Northern Rock Plc in September, the first on a U.K. bank in more than a century. The Financial Services Authority, the regulator overseeing the possible sale of the mortgage lender, said on Dec. 5 that mortgage lenders should brace for tighter credit conditions.

While two policy makers voted for a cut last month, King, Rachel Lomax, Charles Bean and Andrew Sentance expressed concern about inflation in the past month after crude oil reached a record $99.29 on Nov. 21 and food prices rose.

Consumers anticipate the inflation rate to rise to 2.8 percent, a survey by YouGov Plc showed last month, the most since the poll was first conducted two years ago. The Bank of England's inflation target is 2 percent.

`Ritual Bleating'

``No doubt there will be some ritual bleating about the MPC cutting rates at a time when inflation is above target and set to rise further, but monetary policy is supposed to be pre-emptive,'' said Ian Kernohan, an economist at Royal London Asset Management. ``There is more than enough tightening already in the system to bring inflation down later next year.''

Barclays Capital and nine other banks and research groups changed their forecasts yesterday to predict a rate cut after evidence that higher lending rates are starting to affect the wider economy.

Service industries from banks to airlines grew at the slowest pace since May 2003, according to a survey of purchasing managers by the Chartered Institute of Purchasing and Supply. The figures cover two-fifths of the economy.

Mortgage rates are also rising even though the bank's benchmark rate has been unchanged for the past five months. HBOS Plc said house prices fell for a third month in November, the worst streak for property values since 1995, suggesting the decade-long housing boom is coming to an end.

``This cut should make it cheaper for people taking out a new mortgage or coming off existing fixed rate terms, and provide some support to the housing market,'' said Adrian Coles, director of the Building Societies Association. ``Activity in the housing market was already beginning to slow as a result of the previous increases in interest rates, and this is likely to continue.''

To contact the reporters on this story: Brian Swint in London at bswint@bloomberg.net; Jennifer Ryan in London at Jryan13@bloomberg.net.

Last Updated: December 6, 2007 11:05 EST