Bank of England's massive rate cut is double-edged sword

LONDON (Reuters) - The Bank of England's decision to cut interest rates to their lowest level since 1954 is a double-edged sword, with the huge size of the move likely to prompt fear as well as relief.

The biggest British rate cut since a recession in 1981 is a clear attempt to shake off accusations that the BoE has been too slow to make monetary policy suit an economy that is rapidly succumbing to the global credit crunch.

But the scale of the reduction, which lowered rates by a third to 3.0 percent from 4.5 percent, may also confirm Britons' worst fears about the health of the economy.

"It's not a silver bullet," said Jason Simpson, UK rates strategist at the Royal Bank of Scotland.

"They're trying to get ahead of what the market was pricing in order to boost confidence, but they do risk ... (implying) that the economic situation is so dire that they needed to cut rates by an unprecedented amount."

Some economic indicators have been hitting depressing records. Factory output data on Wednesday showed the longest unbroken decline since 1980, and well-known employers such as carmaker Nissan and brewer Carlsberg have been shutting plants in Britain, either temporarily or for good.

But the economy has not yet hit rock bottom, and the longer-term economic benefit of Thursday's rate cut will hinge on whether it succeeds in driving down borrowing costs for firms and households.

The scale of the BoE's move may also be an attempt to force down LIBOR interbank lending rates that underpin much private sector borrowing.

British banks have been reluctant to pass on past BoE cuts and Lloyds TSB was the only one on Thursday to say it would cut its main mortgage rate by the same amount as the BoE.

"Maybe they're throwing caution to the wind to try to get LIBOR rates down a bit more," said Simpson. "We've still got a lot of bad headlines to come over the next six months."

Nonetheless, some economists said it was better that the BoE used most of its firepower at the start of the downturn rather than leaving some in reserve.

"If you keep interest rates at a very low level through 2009 surely that's better at supporting growth than keeping rates higher and moving them 25 basis points at a time," said George Buckley, UK economist at Deutsche Bank.

Either way, Bank of England Governor Mervyn King is likely to be reminded of comments he first made almost a decade ago that central banking should be 'boring' and avoid grand gestures.

But Brian Hilliard, an economist at Societe Generale, said King was unlikely to be reproaching himself for not acting sooner to cut rates.

Though the BoE cut rates in February and April, a surge in oil prices to over the summer -- culminating in inflation peaking at 5.2 percent in September -- meant most policymakers resisted further action before globally coordinated cuts in October.

"There may be some debate if they could have moved a month earlier, but they'd have been criticised by markets if they'd moved while inflation was still rising," Hilliard said.

"Events have moved on. Carping on about whether they should have cut rates earlier is now a bit beside the point."

(Reporting by David Milliken; editing by David Stamp)