Europe's Central Banks Slash Interest Rates

Posted by: Mark Scott on November 06

In a move that exceeded even the most bullish projections, the Bank of England (BoE) on Nov. 6 cut its benchmark interest rate from 4.5% to 3.0%. The 1.5 percentage point drop was well ahead of the 50 basis point reduction that almost all economists had predicted. The European Central Bank (ECB) also made its own interest rate cut on Nov. 6, announcing a 50 basis point reduction to 3.25%. That met with economists’ predictions, although the ECB is still expected to cut rates to 2% by the end of 2009.

The interest rate cut by Britain’s central bank shows just how bleak the economic situation has become. In a statement, the BoE’s Monetary Policy Committee (MPC) said “there has been a very marked deterioration in the outlook for economic activity at home and abroad.” According to data released this week, the British service sector, which represents almost two-thirds of the domestic economy, shrank in October at its fastest rate since 1996. The country’s Office for National Statistics also said manufacturing output in September fell 0.8% compared to August — the seventh consecutive decline and the biggest drop since early 2007.

“Extraordinary times require extraordinary actions. Today’s rate cut is unprecedented in the history of the MPC,” Stuart Porteous, Head of RBS Group Economics, said in a statement. “Markets were crying out for something bold and the MPC has delivered. The slowdown in the real economy is accelerating and I expect rates to fall towards 2%.”

Due to the worsening economic situation, the BoE said attention must now be focused on strengthening the domestic business environment – and not curtailing rising inflation that had been the major concern only six weeks ago. Economists say the 150 basis point cut in interest rates is an attempt by Britain’s policymakers to bolster the domestic economy.

The BoE statement said:

“The upside risk was that above-target inflation persisted for a sustained period because of elevated inflation expectations. In recent weeks, the risks to inflation have shifted decisively to the downside. As a consequence, the Committee has revised down its projected outlook for inflation which, at prevailing market interest rates, contains a substantial risk of undershooting the inflation target.”

In Europe, the economic situation is similarly dire. The euro zone’s manufacturing and service sectors contracted at an all-time rate in October. Consumer confidence also is at a 15-year low.

And even the European Union believes the continent is in for a hard next 12 months. On Nov. 3, the EU said the euro zone’s GDP growth would be a meager 0.1% in 2009, compared to 1.2% this year. That would represent the worst economic performance since 1993.

To make matters worse, the European bourses on Nov. 6 already were feeling the knock-on effects from dour trading in the U.S. and Asia. That, couped with the recent pessimistic data about the continent’s manufacturing industry, service sector, and consumer confidence, led to significant losses by the close of trading. Britain’s FTSE 100 dropped 5.70%, Germany’s DAX lost 6.84%, and France’s CAC 40 had fallen 6.38%.