Global Economics

Bank of England Mulls Historic Rate Cut


The British central bank meets Jan. 7 amid bleak economic signs to consider cutting rates below 2%—the lowest ever in its 314-year history

The Bank of England's Monetary Policy Committee meets tomorrow for an historic session, heralding the lowest interest rates in the Bank's 314-year history and opening up the possibility that the Bank will soon embark on a policy of "quantitative easing", more popularly called "printing money", to avert a severe recession.

City economists have unanimously thought for some time that the Bank would cut rates from their current 2 per cent level, the lowest since 1951. The only question is by how much the MPC will move when the decision is announced on Thursday lunchtime, and what path the Bank will follow as rates move, seemingly inexorably, to zero.

The only immediate restraint on the MPC's freedom is the weakness of sterling. When the Bank cut rates by 1 percentage point at its December meeting, committee members did consider an even greater cut, following the headline-grabbing 1.5 percentage point drop seen in November. However, they reflected at that time that "there was a risk that going further could cause an excessive fall in the exchange rate".

Philip Shaw, UK Economist at Investec, said yesterday: "We are still looking for a 50 basis points reduction to 1.5 per cent this month. It is possible that the MPC opts for a more aggressive 75 basis points or even 100 basis points move. However, the arguments against this are: it may prefer to keep some of its powder dry; the effects of previous cuts in rates and taxes have yet to show through; and sterling has fallen by 7 per cent in trade-weighted terms since last month's meeting."

In any event, official interest rates are set to reach their lowest level since the Bank of England's foundation in 1694, and a move to zero, or close to it, is being canvassed by some. The Deputy Governor of the Bank for Monetary Policy, Charlie Bean, remarked last month that "we may of course find them [interest rates] getting all the way to near zero."

Many are looking beyond the current round of rate reductions towards the authorities' next moves to ease the credit crunch. Some City voices are urging the Bank to immediately begin the process of "quantitative easing" – injecting cash directly into the economy – because of the failure of banks and building societies to pass on reductions in Bank rate and follow the suggestion of ministers that they should return to 2007 levels of lending, or even more.

The refusal of the Nationwide Building Society to remove the "collar" on its tracker-rate mortgages is symbolic of the determination of financial institutions to rebuild margins, profitability and capital, notwithstanding the effects on the wider economy. The Chartered Institute of Purchasing and Supply/Markit reported yesterday yet another record low reading for business confidence in the construction industry.

"Unconventional measures" being discussed include the purchase of government securities, commercial paper or so-called "toxic assets" from the banks, possibly by a state-owned "bad bank", to free the commercial banks to return to more normal lending. Longer term that could create problems of its own. Vicky Redwood, of Capital Economics, warned: "Quantitative easing is not a riskless strategy, with the biggest danger that inflation spirals out of control and/or bond yields soar when the economy is out of the woods. The Bank is therefore likely initially to tread cautiously into such new territory."

A further recapitalisation of the banks is also an option, though the Chancellor, Alistair Darling said at the weekend: "Recapitalisation is not your first port of call."

Provided by The Independent—from London, for Independent minds

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