Mervyn King probably didn’t say “this sucker’s going down”. The Bank of England Governor is unlikely to have described the threat hanging over the economy in quite the same good ol’ boy style as George Bush.

But that must have been the gist of his warning to other members of the Bank’s Monetary Policy Committee on Wednesday. Only such a dire assessment of the risks would have justified the savage one and a half percentage-point cut in interest rates announced yesterday.

In the minds of investors, the bad news is that the Bank fears we are in for a very sharp downturn. The worse news is that the cut may still be too little, too late.

As the implications of the Bank’s decision sunk in, the stock market had another swoon with the FTSE 100 index closing down almost 6 per cent.

The move took virtually all observers by surprise. Many economists were predicting a one-point cut but a large number were forecasting something less dramatic.

Yet, in retrospect, the biggest surprise was perhaps not that rates have come down so far, but that they were so high in the first place.

Yesterday the International Monetary Fund said that the outlook for the economies of the developed world was the worst since the Second World War. The European Commission is cautioning that Britain is facing the sharpest downturn of any large EU country.

Yet until yesterday Britain had interest rates of 4.5 per cent, compared with 3.75 per cent in the eurozone and only 1 per cent in the US.

Critics will argue that yesterday’s cut is an admission that the Bank was plain wrong before. If 3 per cent is the right rate now, how can 5 per cent have been right last month? Knowing what we do now, it would clearly have been better if the Bank had cut before. But, to be fair to the Bank, economic conditions have worsened significantly in the past few weeks, as reflected by the slump in the stock market. Output fell sharply in the third quarter and both official and anecdotal evidence suggest things are deteriorating rapidly. Many business bosses who were relatively sanguine even a few weeks ago are now very nervous indeed.

As the Bank noted in its statement yesterday, the government bailout of leading banks has shored up confidence in the financial system. But lending to households and businesses is likely to remain very tight.

Meanwhile, the threat of inflation has faded fast. Commodity prices, including oil, have fallen sharply and the shift of the economy into reverse will reduce pressure further on prices. This in turn has fed through into lower expectations of inflation among consumers and companies, one of the key factors that the Bank watches.

Until recently, the Bank has felt constrained from cutting interest rates more sharply by its mandate to keep inflation at 2 per cent in the medium term. In September inflation reached 5.2 per cent. But it said yesterday that the outlook is now so dismal there is a real risk that inflation would fall below 2 per cent in the medium term.

What it did not add, is that its mandate is not simply to target inflation. It is also to “support the economic policy of Her Majesty’s Government, including its objectives for growth and employment”.

In recent days the Government has made clear that supporting those policies requires a big cut in interest rates. Both the Prime Minister and the Chancellor have piled on the public pressure, abandoning the hands-off approach they have pursued since the Bank was given independence over interest rates in 1997. The Bank cherishes this independence and some observers felt that the political pressure might backfire.

Sir Steve Robson, the former Second Permanent Secretary at the Treasury, who is a member of The Times “shadow” Monetary Policy Committee, advised the Bank to limit a cut to a half point to make clear it did not “dance to the tune of politicians”. Other experts urged the Bank to maintain gradualist approach, arguing that repeated small cuts in rates were more effective than one big bang.

But the Bank’s committee has swung behind those members, such as Andrew Sentance, who advocated more aggressive tactics, and, most critically, Mr King has shifted his focus from inflation to growth in line with David Blanchflower, the arch rate-cutter on the committee. The big question now, of course, is — will it work? In normal times such a big cut in rates would provide a big shot in the arm for the economy. These are not normal times. The banks and building societies have pointed out that they will not automatically be able to pass through the cut in base rates to borrowers, an argument that has infuriated ministers. Nonetheless, it is likely that much of the benefit of the rate cut will flow through to borrowers, partly offset by a loss to savers.

J P Morgan estimates that it will lower interest payments on existing mortgages by about £10 billion in a full year. This in itself will not prevent a severe downturn.

But the grim language of the Bank’s statement suggested it was ready to make further cuts. Economists now think rates could fall below 2 per cent next year, the lowest since records began in 1694. Even that may not stop the sucker going down. But it should make the fall a great deal less painful.

HARD TIMES

1854 (the last time rates were cut by 1.5 percentage points)

The horrors of war in the Crimea are brought home in dispatches to The Times from William Russell. The horrors of sweat-shop labour are brought home to the reading classes via Charles Dickens’s Hard Times. In London, a cholera epidemic sweeps the city. Dr John Snow maps its spread and proves his own, then controversial, theory that the disease is linked to contaminated water

1954 (the last time rates were at 3 per cent)

A year of freakish weather: the Metereological Office tries to calm the public, saying summer storms are merely “a random variation among the infinite variations of nature”. It is otherwise a year of transition from postwar austerity to consumer boom: rationing ends and building licences are scrapped as the Tory Government seeks to liberalise the economy

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