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Bank of England springs a shock

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Nov 7, 2008

By Hugh Pym

Shock, horror, drama - the Bank of England has cut interest rates by a lot more than anyone had expected.

Pinch yourself, the Bank's Monetary Policy Committee (MPC) has slashed the cost of borrowing by one-and-a-half percentage points to 3%.

Those of a nervous disposition may need to lie down for a while. After all this is an institution which, according to the bank's governor, likes to be dull and predictable.

The Bank has never cut rates by anything on this scale since it was given independence and control of monetary policy in 1997.

You have to go all the way back to the recession of the early 1980s to find the previous reduction of one-and-a-half percentage points in the cost of borrowing (that is excluding the unusual gyrations around Black Wednesday and Britain's exit from the Exchange Rate Mechanism in 1992).

Too late?

This is truly a historic move. History will judge whether it was a bold and radical initiative which prevented the economy sliding into a deep and prolonged recession.

Business leaders have welcomed it in that vein. After all, the Bank went further than the major employers' organisations had dared to ask for.

History will also relate whether the Bank moved too late to save the economy from the consequences of a damaging downturn.

One member of the MPC, David Blanchflower, has been calling for lower rates for some months now. He will feel entitled to say "I told you so".

Intriguingly the European Central Bank (ECB) only reduced its lending rate by half a percentage point to 3.25%.

UK interest rates are now lower than the eurozone's for the first time since the single currency was introduced in 1999.

So is the ECB now behind the curve? Or is it that the UK is now facing the most severe downturn of any leading European economy?

Next week's publication of the Bank's Inflation Report will shed valuable light on where it thinks the economy is heading.

It may well paint an even bleaker picture for UK growth prospects (or lack of them) than most forecasters have painted to date.

Remember, MPC members will have read the report before making their decision today. You don't vote for a one-and-a-half percentage point cut if the latest forecast suggests only a mild recession.

Wait and hope

Jaguar Land Rover, now part of India's Tata group, is one leading UK-based company that went public with a call for a one percentage point reduction.

The firm's chief executive David Smith said: "We need a real shock to the system that a significant rate cut will provide".

Business leaders of that ilk don't go public with such a call if they aren't highly concerned about the outlook for the economy.

The Bank of England, and businesses, can now only sit and wait and hope.

The hope is that the shock value of the rate cut will rekindle consumers' interest in shopping and spending.

The fear is that people have decided to batten down the hatches no matter what the cost of borrowing is.
Source: BBC

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