Interest rates cut by one third - but will that help?
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Associate Editor
David Stevenson Dec 04, 2008
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Can the Bank of England shelter us from the storm?
Another 1% off. The Bank of England's Monetary Policy Committee has just slashed the benchmark base rate to 2%.
The last time the rate hit this level was 1951, and it's never been lower since the Bank's foundation in 1694. Dramatic stuff – but widely predicted by the 'experts', according to Bloomberg's survey, with some immediately calling for even more cuts as the economy nosedives.
But the big question remains: is Britain now in such a mess that no amount of rate cutting will make much difference?
In 'normal' times, we've all been used to miserly quarter point official loan cost moves - in either direction. But as we all know, these aren't normal times. Even 1% moves are considered almost puny nowadays, in the current "anything you can do, I can do better" rate-slashing scene.
New Zealand started the ball rolling very early this morning with a record 1.5% cut to 5%, followed at 8.30 am by Sweden with a much bigger than expected 1.75% slice off its Riksbank rate, to 2% - the largest chop Stockholm has seen since 1992. It was accompanied by a reduced official 2009 GDP forecast to -0.5%.
The US Fed funds rate has already been lowered to 1%, down from 5.25% just 15 months ago. And the European Central Bank has just joined the party by producing the most aggressive rate reduction in its 10-year history, a 0.75% cut.
It's all because economies around the world are in a mess. Not only is a very nasty recession on the horizon, so is a potentially destructive period of deflation – falling prices. We look in detail at what this means in our latest issue out tomorrow (get your first three issues free here).
So despite the Bank of England's base rate now standing at a level equal to its lowest for over 300 years, even more is expected. Former MPC member Willem Buiter reckons that official rates could reach zero early next year, after another major downward move in January.
Why? Like everyone else, our economy is in freefall. More bad news today included a Halifax report, showing that house prices saw their biggest monthly drop since 1992 in November, down 2.6%. They've now fallen 16% on last year. Meanwhile, new car registrations fell in November at the fastest pace yet, down 37% against last year.
But worse still, here in Britain, whatever our political masters tell us, we seem to be in just about the biggest mess around. Don't just take our word for it - look at probably the best financial barometer there is for confidence in a country, our currency.
The pound is heading right down the drain. Today it has hit an all-time low against the euro and its weakest level in more than six years against the US dollar. And rate cuts to zero will only weaken sterling further as the full ghastly story emerges.
What do I mean?
Britain's boom was a fraud. It was based, quite simply, on debt. We're much more individually indebted than most of the rest of Europe. We now personally owe more (£1,455bn) than we've ever owed before, and have bigger debts to the banks than we produce every year.
And our government's solution? Spend money like water, and run up public borrowing to new highs as well. Yet the plunge in sterling is going to make this much harder to achieve. Much of the cash will have to be borrowed from abroad. Yet investors are going to shirk away from buying gilts if they think they'll lose out on the exchange rate.
So the bottom line is that despite the dramatic nature of these cuts, the actual impact they'll have won't be that great. Sure, some mortgage borrowers will find their monthly payments coming down. But for new lending, most of the government's public pressure on the banks is just showboating. Banks will carry on the way that they always have. Lower base rates aren't going to increase the amount of credit available.
As David Wighton says in The Times, "the mechanism that turns official interest rate cuts into a boost for the economy is broken". And the real problem is very simple indeed. However much cash is dangled in front of us, and regardless of the rate of interest, we literally can't afford to borrow any more money.
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