Aug. 4 (Bloomberg) -- The Bank of England cut interest rates for the first time in two years today as growth slowed in Europe's second-largest economy, while the European Central Bank kept rates unchanged for a 26th straight month amid signs of an upswing.

The Bank of England's nine-member Monetary Policy Committee cut its repurchase rate by a quarter point to 4.5 percent, as predicted by 35 of 40 economists in a Bloomberg survey. The ECB's decision to keep rates unchanged at 2 percent, a six-decade low, was expected by all 42 economists in another survey.

``The U.K. is coming off a period of fairly strong growth, momentum has slowed, and the BOE needs to put a floor under that weakness,'' said Peter Dixon, an economist at Commerzbank AG in London. ``The euro-zone economy is recovering slowly and monetary conditions are already very expansive. There's not a lot more the ECB can do.''

The U.K. economy grew at the slowest annual pace in 12 years in the second quarter as record oil prices, the end of a property boom and rising unemployment sapped consumer spending. In the euro region, improving business confidence and industrial production suggest the economy is recovering from a second-quarter slowdown.

U.K. borrowing costs are still the highest among the Group of Seven richest nations after the central bank raised the repurchase rate five times between November 2003 and August 2004. By contrast, the ECB's benchmark rate is the lowest for any of the dozen nations using the euro since at least 1946.

`A Cut to Help Demand'

The U.K. economy may expand 2 percent this year, the National Institute of Economic and Social Research, which advises the Bank of England and the Treasury, said July 29. That compares with 3.2 percent last year and the 3 percent to 3.5 percent predicted for 2005 by Chancellor of the Exchequer Gordon Brown.

``It was a cut to help demand, which has weakened all round this year,'' Geoffrey Dicks, chief U.K. economist at Royal Bank of Scotland Plc, said after the Bank of England's decision.

U.K. output growth was ``subdued'' in the first half of the year, the bank said. ``Household spending and business investment growth have slowed.''

Ninety-seven U.K. companies trimmed their earnings forecasts in the second quarter, the most warnings in a quarter since 2002, Ernst & Young LLP said in a study on July 18. London-based Marks & Spencer Plc, the U.K.'s biggest clothing retailer, said on July 13 sales at stores open a year or more fell for a seventh quarter.

Slowing house-price inflation may be partly to blame for weaker consumer spending. House price inflation slowed to 2.6 percent last month, the lowest rate in nine years, the Nationwide Building Society said on July 28. Barratt Developments Plc, the U.K.'s third-biggest homebuilder by market value, yesterday called for an interest-rate cut to boost the market and growth.

Across the Channel

Across the English Channel, politicians including Italian Prime Minister Silvio Berlusconi and German Economy and Labor Minister Wolfgang Clement have urged the ECB to pare rates to help growth in the euro economy, which will expand just 1.3 percent this year compared with 2 percent in 2004, according to European Commission forecasts.

Still, the commission said July 18 it expects growth to rebound in the second half after a ``disappointingly slow'' second quarter. Business confidence rose in Germany, Italy and France in July, signaling growth may pick up. German factory orders unexpectedly surged in June, increasing 2.4 percent from the month before, the Economics and Labor Ministry said today.

``Surveys are surprising on the upside so rate cuts look to be off the ECB's agenda for now,'' said Guillaume Menuet, senior economist at Moody's Investors Service in London. ``If euro zone growth returns to trend, as we expect, it will be hard for the ECB to justify maintaining such an accommodative policy.''

Inflation Risk

While the euro's 10 percent decline against the dollar this year is helping growth by making European goods cheaper abroad, it is also exacerbating record oil prices, pushing euro-area inflation above the ECB's 2 percent ceiling.

Inflation accelerated to 2.2 percent in July, a seven-month high, from 2.1 percent in June, the European Union's statistics office said on July 29. The euro was at $1.2327 today, down from a record $1.3666 on Dec. 30. Oil cost $61.26 a barrel in New York after rising to a record $62.50 yesterday.

``Interestingly enough, the inflation outlook in the U.K. is not that different,'' Commerzbank's Dixon said. ``Both central banks are faced with inflation pretty much bang in line with their targets.''

Inflation in the U.K. reached 2 percent in June, the central bank's target. A slackening in demand ``should lead to some moderation in inflation,'' the Bank of England said.

Differing Cycles

Until the end of last year, growth among the dozen nations sharing the euro had lagged the U.K. pace in every quarter since 2000. ``The euro zone entered a slowdown in the early part of the decade and hasn't gained momentum since,'' said Dixon. ``It's hampered by governments' unwillingness to implement structural reforms, and the ECB can't do much about that.''

Chancellor Gerhard Schroeder has tried to loosen Germany's labor market by cutting benefits for the jobless who refuse work and putting 360,000 former social-welfare recipients back in the work force. Voters rejected his policies in regional elections, leading him to seek an early national vote on Sept. 18.

According to International Labor Organization measures, the U.K.'s annual unemployment rate in the three months through May was 4.8 percent, up from 4.7 percent in the quarter through April. Unemployment in the euro region was unchanged at 8.7 percent in June, the European Union statistics office said Aug. 2.

Moody's Menuet said another reason for the contrasting stances of the central banks is that the two economies are at different stages in their cycles.

``Toward the end of 2006 we might see the U.K. economy stabilizing and the BOE might look at starting to raise rates again,'' he said. ``By then, the ECB will also be raising rates, so we might see a convergence of the cycles by the end of 2006.''

To contact the reporter on this story: Matthew Brockett in Frankfurt at mbrockett1@bloomberg.net.

Last Updated: August 4, 2005 08:30 EDT