The Bank of England yesterday bowed to the overwhelming pressure of gloomy economic data and hacked a quarter of a percentage point off base rates, bringing themdown to 5.5% - the first cut since August 2005.

After a week of feverish speculation, a growing number of economic analysts now believe a string of base-rate reductions may follow - with some suggesting the cost of credit could tumble as low as 4% next year, although most were more tempered in their forecasts.

While yesterday's news was welcomed by homeowners, who are already squeezed by rising fuel, food and mortgage costs, the base-rate cut reveals that the Bank's Monetary Policy Committee remains concerned that the UK economy is heading towards a sharp slowdown.

Nonetheless, the quarter-point reduction, which could knock around £16 a month off the cost of a typical £100,000 mortgage, will be cheered by most homeowners.

The MPC's statement which accompanied its decision admitted there are signs the economy's expansion rate had begun to slow.

However, it also said the pace of the slowdown remained "broadly in line with the projections contained in the November Inflation Report" - in other words, the slowdown alone was not sufficiently worrying to prompt the cut.

The central bank said the cut, which reversed July's hike, was also needed because the state of financial markets was getting worse, piling pressure on both firms and consumers.

Lucy O'Carroll, director of research at Bank of Scotland's treasury division, said: "What seems to have been the clincher is financial-market conditions, which have deteriorated further since the committee's November meeting, tightening the supply of credit to both households and businesses and therefore, in the words of today's statement, posing downside risks to the outlook' for both inflation and output further ahead."

Only a handful of economists were last week predicting the Bank of England would cut this month, because policymakers were still worried about inflation, given the soaring cost of food, oil and other commodities.

However, all that changed on Wednesday, when one survey showed house prices falling sharply and another that the country's huge services sector had slowed even further in November.

Banks tore up their forecasts of no change and the City - not to mention the tabloid press - began screaming for lower borrowing costs to prevent a sharp slowdown in the economy and a crisis among homeowners.

David Brown, an economist at Bear Stearns, said: "The Bank of England has pulled the rip-cord to much lower rates."

Roger Bootle, economic adviser at Deloitte, added: "Today's decision is the first step in a prolonged period of monetary easing that could see rates fall very sharply.

"I previously thought that rates would drop to 5%, but I now think that they could eventually be cut all the way to 4%."

Even the Paris-based Organisation for Economic Cooperation and Development yesterday released a statement, in the crucial hours before the announcement of the MPC's decision, saying the Bank of England should cut interest rates now to prevent an economic slowdown turning into a prolonged downturn.

Andrew McLaughlin, Royal Bank of Scotland Group chief economist, said: "If ever a rate cut was aimed at animal spirits in the economy, this was it."

However, he conceded: "Inflation remains a concern for many committee members and some will have voted to cut through gritted teeth."

Markets are now anxiously awaiting the minutes of the MPC meeting in two weeks to see how many members voted for a cut.

The Bank of England yesterday acknowledged that risks to inflation were still on the upside but it said the slowing in the economy should reduce the pressure to raise prices.

Stock markets and interest rate futures which had initially rallied on the decision fell back as investors took in the comments to mean that another cut was not inevitable.

Malcolm Barr, an economist at JP Morgan, said: "The MPC is trying to portray the move as bringing forward the timing rather than a downpayment on more.

"And the explicit mention of upside risks' to inflation, which the committee will continue to monitor carefully', serves to reinforce the hawkish tone of the statement as a whole."

At the same time, not all the economic data has been bad.

Official figures out yesterday from the Office for National Statistics showed manufacturing output rising more than expected - helped by a pick-up in the aircraft and shipbuilding industries - and other surveys have shown businesses not being hit too hard by the credit crunch.

O'Carroll added: "For now we remain of the view that the likely rate trough is a shallow 5% by mid-2008 at the latest, with the next cut coming early in the new year."

Meanwhile, the European Central Bank held its key interest rate steady at 4% and warned that tension in the markets made it difficult to gauge the economic outlook for the 13 countries that use the euro currency. The ECB has held back from raising rates as inflation picks up pace, worried about the effect on the eurozone of the sub-prime mortgage debacle that originated in the US and spread worldwide.