Shares rebounded to rise nearly 3 per cent yesterday as expectations soared that the Bank of England would begin its long-heralded programme of rate cuts today.

The surge in expectations of the first interest rate cut since August 2005 followed a surprisingly weak survey of the service sector. Bets that the Bank would take action today at the conclusion of the two-day meeting of the Monetary Policy Committee (MPC) sent the pound tumbling on the foreign-exchange markets, hitting its lowest level against the euro in four years.

The FTSE 100 index rose by 2.8 per cent to 6,493.80 points, with oil and energy stocks and banking shares among the leaders. Royal Bank of Scotland was among the top percentage gainers, rising by more than 6 per cent in its largest rise in a month, while HSBC and Barclays each rose 3 per cent. Banking shares benefited from a growing expectation that the Bank would cut rates today. Most economists had expected rates to stay on hold this month but a rash of gloomy figures has prompted many banks, including Barclays, Merrill Lynch and RBC, to change their call.

Yesterday’s CIPS/RBS purchasing managers’ index of the service sector, perhaps the most closely watched survey of economic output, showed that the financial sector suffered an outright fall in activity in November for a second successive month, as the service sector in general grew at its weakest rate since May 2003.

Simon Hayes, UK economist at Barclays Capital, said that the housing market had weakened and was likely to deteriorate next year because of the credit crisis.

The downturn in the PMI survey over the past two months confirmed that the risks of weaker growth identified last month by the MPC were justified, he said. As a result, “although it remains a close call”, it was now more likely than not that the Bank would cut rates this month. He forecast that Bank rate would drop as low as 5 per cent by the middle of next year.

A separate report from the CBI added to the gloom for the service sector. The business group’s quarterly survey showed that spending in some consumer-facing services, such as cinemas, gyms and hairdressers, fell in the three months to November at the fastest rate in the ten-year history of the survey. However, firms providing professional services to business, such as telecoms, IT consulting, architects and recruitment agencies, reported that growth in their business volumes held up rather better over the past three months.

Adding to the woes of financial institutions, and strengthening the case of the doves on the MPC, who are calling for an immediate cut in rates, inter-bank rates rose yet again yesterday to a fresh nine-year high. But the Bank’s hawks will be concerned about persistent inflationary risks from imported commodities such as oil and food, and yesterday’s drop in the value of sterling will bolster their arguments.

The pound sank against the euro to drop as low as €1.3831. Against the dollar, sterling fell by 1.4 per cent to $2.0281.

In Zurich, Josef Ackermann, the chief executive of Deutsche Bank, delivered an ominous warning that the credit crisis was not over yet. “The nervousness is back,” he said. “The problem is that banks don’t want to take risks at the year end and hoard liquidity. The next weeks will be very, very difficult again.”

He said that a moderate slowdown in the eurozone was taking place, but demand from Asia and Eastern Europe would support growth.

Jeremy Batstone-Carr, head of private client research at Charles Stanley, said: “It is entirely clear the market is betting on 50 basis points from the Bank [of England] tomorrow.

“We’re getting to the end of the corporate reporting season, so the focus is hugely on the macro picture at the moment, but I think it’s far too early to say just because the central bankers are cutting interest rates that we’re out of the woods.”

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