LONDON (Reuters) - The Bank of England cut interest rates for the third time in five months yesterday to cushion the economy from the global credit squeeze, despite persistent worries about rising inflation.

The central bank said the quarter-percentage point reduction in its main rate to 5.0 percent was justified even though inflation was likely to spike this year.

"Credit conditions have tightened and the availability of credit appears to be worsening," the BoE said in a statement.

"The disruption in financial markets could lead to a slowdown in the economy that was sufficiently sharp to pull inflation below target."

Financial markets priced in a greater chance of more rate cuts as those words compounded existing fears over the economy.

The possibility of lower interest rates is likely to come as a relief to Prime Minister Gordon Brown who is falling increasingly out of favour with voters as his reputation for economic competence loses its shine.

Brown, who has to call an election by May 2010, risked the ire of the staunchly-independent BoE this week by saying low inflation meant Britain could cut interest rates, even though inflation is well above the government's two-percent target.

The Bank made clear in its rate statement that policy-makers remain worried about higher prices becoming entrenched in the public mindset, but said weaker growth abroad should keep inflation in check over the medium term.

BoE Governor Mervyn King has dubbed this year the toughest challenge since the bank won independence to set interest rates in 1997 as inflation picks up but growth slows as the global credit crunch bites.

It is a dilemma shared by most central bankers around the world. The European Central Bank kept rates in the euro zone steady yesterday because of inflation fears, but the US Federal Reserve has slashed borrowing costs this year.

However, with ever more experts predicting the UK slowdown will be sharper than official forecasts and the International Monetary Fund predicting the weakest growth in more than a decade this year, hopes for further cuts in Britain are growing.

A Reuters poll showed 36 of 56 economists anticipate the BoE will trim rates again by June.

Only a few weeks ago, a rate cut this month had seemed an outside bet but market sentiment has changed swiftly. The public mood has also darkened due to heightened fears of a recession in the United States and a worldwide economic downturn.

"This is as tough as I've known it," Philip Green, one of Britain's most successful retailers, told Reuters yesterday, describing the economic climate as "ugly".

Credit market turmoil has made banks reluctant to lend, meaning little, if any, of the two BoE rate cuts since December has been passed on to consumers and businesses.

Two of Britain's top mortgage lenders — Nationwide and Alliance & Leicester — actually raised their interest rates for the second time in days yesterday.

"The medicine may not get through to the patient," said Andrew Smith, chief economist at KPMG. "Even if money market rates fall in tandem, which is questionable, the cut may not be reflected in mortgage and commercial loan rates."

"With the impact of monetary policy now blunted, rates will ultimately have to fall further to achieve the same result."

Britons are also being squeezed by higher food and energy prices — which policy-makers say they can do little to fix. Inflation has been above the two-percent target since October and is likely to rise further in the next few months. If inflation spikes too high, the BoE may find it increasingly difficult to justify any further monetary policy easing.