British Interest Rate at Historic Low

Posted by: Mark Scott on January 08

So here’s a quick quiz. Name the odd one out: the Jamestown colony, British monarchs William and Mary, and the number 1.5. Give up? Well, the first two were around back in 1694, while 1.5 — as in the Bank of England’s (BoE) benchmark interest rate of 1.5% — wasn’t. That’s because the BoE’s Monetary Policy Committee (MPC) on Jan. 8 slashed rates 50 basis points to 1.5% — the lowest levels since the country’s central bank was founded over 300 years ago.

The historic move comes as policymakers fret about Britain’s deteriorating economy. With the country already entering its third consecutive quarter of negative growth, indicators from real estate to retail point to move bad news ahead. According to mortgage lender Halifax, house prices in December fell 16.2% annually, with similar double digit declines expected in 2009. The Confederation of British Industry, a trade body, says confidence amongst retailers is at a 25 year low, while researchers Experian are predicting the High Street to keep suffering until 2010, at the earliest.

“Even with major discounting over the holiday period, it hasn’t been enough to save Christmas for the retailers,” says Jonathan De Mello, director of Experian’s retail consultancy.

With so much doom-and-gloom, it's not surprising the BoE moved again to lower interest rates. Since September, 2008, the bank's Monetary Policy Committee has cut rates from 5% to the current 1.5% levels. The question now, however, is what to do next. Despite a multi-billion plan to recapitalize British banks and a round of sales tax reductions and other economic stimuli, Britain is still expected to remain in the doldrums for the next 12 to 18 months.

One idea that's getting a lot of play in the media is to increase the supply of money and use the extra cash to buy assets from government bonds to private equities. According to the Times of London: "The policy of increasing the money supply to relax monetary conditions is being looked at as a 'sensible contingency plan'"

Government officials have played down the rumor, although new measures to prop up Britain's now flailing economy are much needed. "Few people, and certainly not the MPC, question the challenges [Britain] faces in 2009" writes Stuart Porteous, head of RBS Group Economics, in a statement. "As rates head towards zero, policymakers will be forced to embark on ever more unorthodox measures to get the economy moving again"

To make matters worse, the British Pound has lost roughly a third of its value against the Dollar and dropped a quarter against the Euro -- it's now trading at almost parity. That's good news for exporters (although beleaguered foreign markets show little appetite for British goods), but it has hit both domestic consumers and financial investors, who are now questioning the logic of holding Pound-denominated investments.

Looking forward, economists aren't ruling out more cuts in Britain's benchmark interest rate. Yet after the Jan. 8 decision pushed rates to a 314-year, historic low, further reductions really would be unchartered territory.