Bank cuts rates to 5 pct

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The central bank said the quarter percentage point reduction in its main rate to 5.0 percent was justified even though inflation was likely to spike in the short term.

"Credit conditions have tightened and the availability of credit appears to be worsening," the Bank said in a statement.

"The disruption in financial markets could lead to a slowdown in the economy that was sufficiently sharp to pull inflation below target."

Financial markets moved to price in a greater chance of more rate cuts following evidence of a downturn in the housing market, falling consumer confidence and a bleaker economic outlook due to the credit crisis.

The prospect of lower interest rates is also likely to come as a relief to Prime Minister Gordon Brown who is falling increasingly out of favour with voters as his reputation for economic competence loses its shine.

Brown, who has to call an election by 2010, risked the ire of the staunchly-independent Bank this week by saying low inflation meant Britain could cut interest rates, even though inflation is well above the government's 2 percent target.

The Bank made clear in its rate statement that policymakers are still worried about the chances of higher prices becoming entrenched in the public mindset, but weaker economic growth abroad should keep inflation in check over the medium term.

Bank Governor Mervyn King has dubbed this year the toughest challenge since the central bank won independence to set interest rates in 1997.

The European Central Bank kept rates in the euro zone steady at 4.0 percent on Thursday because of inflation fears.

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