Bank of England to Cut Rate Close to Zero

The Government is putting the finishing touches to a letter to the Bank endorsing its proposal to embark on this radical policy.

The Bank's governor, Mervyn King, will be granted approval
by the Treasury within days to create up to £150bn in new money in the coming months to buy up everything from corporate bonds to government debt. It will pave the way for the Bank's Monetary Policy Committee effectively to "start the presses" at its interest rate setting meeting this Thursday.

The move is the latest stage in the Bank's efforts to prevent the economy from sliding towards deflation.

The MPC is likely also to cut interest rates at its meeting to a new unprecedented low of 0.5pc at its meeting this week, with some anticipating that it may reduce them to a nominal point just above zero.

The eventual level that rates will hit depends on whether Bank experts have calculated that at these kind of levels further cuts in borrowing costs would have any extra effect.

Many mortgage lenders are refusing to pass on further cuts in borrowing costs to their customers,

But most significant of all will be the MPC's undertaking at the meeting this week to start buying government bonds in what many see as the "nuclear option" for monetary policy.

Experts said it will use the statement accompanying the decision to indicate that it plans to push rates down towards zero in the long run.

But, more significantly, the Bank will indicate in an exchange of letters with the Treasury that it intends to pump a significant amount of cash into the markets, by buying commercial paper and corporate bonds alongside gilts. The amount it is likely to spend on these purchases will probably be around £5bn-£10bn a month.

The scheme is distinct from the existing £50bn Asset Purchase Facility in as much as it will fund the purchases by creating money rather than raising it in the capital markets through the debt management office.

Michael Saunders, chief UK economist at Citigroup said: "If done on a large enough scale, [quantitative easing] is a powerful form of stimulus.

"It is likely to ultimately stabilise the economy and buy time for the financial system to heal - unless the stimulus has to be withdrawn because of signs that inflation expectations are ramping higher - for instance a collapse in the pound, surge in survey measures of inflation expectations or sharply higher gilt yields.

"Of course, if and when the recession eventually ends, the MPC will face the major challenge of judging when to scale back QE.

"It may be a long and uncertain road back to normal monetary policy."