King Lowers Expectations BOE May Reduce Benchmark Interest Rate

Bank of England Governor Mervyn King said an interest-rate cut may do more harm than good at present because of the damage it may cause to some banks’ margins, confounding some economists’ expectations for a move soon.

“It would damage some financial institutions and it would therefore in all probability have an element at least of being counterproductive, which is precisely why we haven’t cut bank rate,” King said at a press conference in London today. “If that situation were to change, and it is possible that the impact on the net interest margins of smaller banks and building societies might diminish, then that could be something that could be contemplated.”

King’s remarks sparked a rise in the pound, and suggest the U.K. won’t soon shift its policy closer to that of its international counterparts. The European Central Bank is in its second month of keeping deposit rates at zero and the Federal Reserve’s main interest rate has been close to zero for almost four years. Japan’s overnight target rate has stayed between zero and 0.1 percent since October 2010.

Some economists including Simon Hayes at Barclays Plc had forecast a reduction in the U.K. benchmark after Monetary Policy Committee members said in the minutes of last month’s meeting they would review the merits of a cut after assessing the impact of their new Funding for Lending program, designed to stoke credit.

‘More Forthright’

“The governor’s comments were more forthright than I would have expected, and you certainly couldn’t be more confident in a rate cut after what he said today,” Hayes said. “The fact that it was mentioned in the minutes suggest that maybe the governor’s view on this is one end of the MPC’s spectrum, and he’s keener to maintain the focus on quantitative easing than perhaps other members are.”

Hayes said he was maintaining his call for a quarter-point cut in November and a 50 billion-pound increase in quantitative easing. Minutes of the Aug. 2 policy decision, where the bank expanded QE to 375 billion pounds, will be published on Aug. 15.

The pound strengthened for a second day against the euro, gaining 0.6 percent to 78.88 pence as of 2:29 p.m. in London. Against the dollar, it rose 0.1 percent to $1.5643.

Investors have scaled back bets on an interest-rate reduction, according to Sonia forward contracts. A cut isn’t priced in through July next year, data from Tullett Prebon Plc shows. Earlier this month, traders were betting on a reduction as soon as this October.

King also said today that a rate cut is “neither here nor there” in the context of an economy that’s been stagnant for the past two years.

“Another quarter point on bank rate is not going to be the difference between having a recovery and not having a recovery,” he said. “We’re in different territory in looking for instruments that would get us out of these difficulties.”

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