BoE prepares for 'step into the unknown'

The "step into the unknown", as the move has been described, is likely to be accompanied by a further cut in interest rates to 0.5%, according to a survey of 53 economists.

It is thought that members of the MPC will turn to quantitative easing to stave off the threat of deflation, which some economists fear will take hold in the autumn.

It is also hoped the scheme, where the Bank of England would buy securities from commercial banks in exchange for a boost in their reserves, would kick-start lending to the rest of the economy as businesses and households continue to warn of shrinking credit.

The MPC has in the past fortnight been giving strong hints that it is preparing to provide "additional stimulus" to the economy as interest rate cuts look increasingly ineffective in the face of deteriorating economic conditions.

Speaking at the Institute of Economic Affairs last week, MPC member Andrew Sentance indicated the Bank was about to take a leap in the dark.

He said: "A persistent and prolonged period of deflation still remains an outside risk in my view. But there is a strong case for providing additional stimulus to the economy to head it off more decisively."

Chancellor Alistair Darling is expected to set strict parameters for the amount of "new money" that will be pumped into the economy through the bank's first experiment with quantitative easing. Estimates vary between 60bn and 140bn.

However, Jonathan Loynes of Capital Economics warned quantitative easing will not be a panacea for the economy's problems, and there are heavy risks involved.

He said: "There's absolutely no guarantee it will feed through to lending in the wider economy. In Japan (where they tried quantitative easing during the 'lost decade' of the Nineties] the banks just decided to sit on the money.

"They could opt to buy assets directly from the private sector but again there is no guarantee corporates will take that money and spend or invest it. You could get to a situation where companies themselves are hoarding the money.

"They have got to try it but I wouldn't bank on it having a very strong effect."

Jeremy Batstone-Carr, director of private client research at Charles Stanley stockbrokers, warned that quantitative easing could also provoke another run on the pound, and push inflation back up in the long-term.

The Consumer Prices Index, the most common marker of inflation, remains 1% over the Bank's 2% target, and Batstone-Carr warns interest rates may have to rise rapidly if inflation rears its head again. This could lead to a second inflation-fuelled crisis in 2011.

"We expect to see a double dip, with recessionary activity re-emerging in 2011/2012," he said.