Interest rates may be slashed - but it won't do any good
By
Associate Editor
David Stevenson
Oct 06, 2008
The Bank of England is almost out of bullets
Amid all the panic and chaos and various bail-out ideas flying around, one traditional panic measure has been conspicuous by its absence – emergency interest rate cuts.
That could be about to change.
“Interest rates in Britain to drop to a 50-year low, with a start expected this week,” headlined The Sunday Times yesterday. And a whole clutch of economists - I’m not quite sure what the collective noun is - has just urged the men, and woman, of the Bank of England’s Monetary Policy Committee (MPC) to start chopping the Bank’s base rate straightaway by at least 0.5%.
Normally, of course, the biggest single monthly cut since 2001 would be seen as good news. But these aren’t normal times. Not only will a massive cut in ‘official’ loan costs just confirm what a complete mess the economy’s really in, it won’t stop more companies crashing...
Why interest rates are likely to be cut very soon
It’s certainly starting to look like the Bank of England base rate could be trimmed a fair bit faster than most people thought likely a month ago. Annual consumer price growth hit a 16-year high of 4.7% last month. And Bank governor Mervyn King was hinting that headline inflation could even reach 5% soon, a country mile away from the Bank’s 2% target.
But then that was before Bradford & Bingley had gone to the wall, along with another batch of European and American banks. And now more and more governments are being forced to back-stop their banking systems, with Germany the latest, and arguably most significant, to guarantee savers’ deposits (more on this on the website later).
Inflation has turned into yesterday’s story (something we’ve been pointing out for a while). Analysts at BNP Paribas and Royal London Asset Management now predict a half-point base rate drop from the current 5%, says Bloomberg. Global Insight reckons the base rate will fall to 3.25% next year, below the 50-year low of 3.5% hit in 2003.
Even that might not be the bottom. "Our base case is for about 3.25% base rates by late 2009," says Michael Saunders at Citigroup. But "rates may have to go even lower if the vicious circle between the economy and financial conditions continues to worsen. In the past week, there have been clear signs the economy is falling off a cliff". JP Morgan economists agree: "with the numbers deteriorating rapidly, we are lowering the forecast for the low in policy rates to 3%".
But it will be much less effective than it used to be
And that’s the nub. A member of the Institute of Economic Affairs’ “shadow MPC” – which looks to second-guess interest rate policy - believes recent financial events "defy hyperbole", says The Times. The economy’s already in such a deep hole that it’s going to take a Herculean effort to dig it out again. Even savage rate cuts will be much less effective than they used to be - like "using a peashooter against a tank" was the reported verdict of one shadow MPC member.
Why? Well, for a start, Mervyn King has been throwing cash around like crazy, promising to take "all actions necessary to ensure the banking system has access to sufficient liquidity".
He’s desperate to get banks lending to their customers again. But the banks don’t want to play ball, or certainly not at rates their customers want to pay. Bankers, or at least those that haven’t gone to the wall, are scared witless about making any more mistakes. Having handed out loans on a plate to legions of American mortgage borrowers who couldn’t pay then back, they’re turned full circle. Now they’re hoarding what cash they have left, and also what they’ve managed to cadge off the Bank.
So global money market rates have soared to their highest levels for years. Fixed-rate mortgage deals - which are priced off money market rates - are rising again, doing more damage to house prices, which are already falling at their fastest since at least 1991, according to the latest Nationwide survey.
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Companies will find it ever-harder to borrow money
But it’s all even worse news for British businesses which make or sell things, and which are already suffering a cash flow crisis.
Companies are digging into their credit facilities at the fastest rate since the 1992 recession, according to the latest Bank money supply numbers. Now these firms can’t get their hands on the loans they need to pay their bills.
At least 21 members of the FTSE 350 index have to raise major chunks of money between now and the end of the year, with almost £50bn of publicly-traded debt coming up for renewal.
Add in bank borrowing, and the total corporate shortfall could be close to double this. What’s more, UK banks plan to scale back their lending even further in the final quarter of the year, last week’s Bank credit report showed.
“There will be companies that will face crises,” says Pippa Wicks at AlixPartners. "People have to wake up and smell the coffee. There’s a real risk that lots of the refinancing will not get away”. She adds that some of her clients are facing borrowing cost hikes of as much as 7%, while her colleague Eric Benedict forecasts that “default rates will triple or quadruple in the coming months”.
In a nutshell, “official” interest rates have become an anachronism in money markets ruled mainly by fear of default. All that financial market stress is about to crush the ‘real’ economy. And business investment and jobs will be amongst the first casualties. Yes, credit may ultimately get cheaper, but only because borrowing has dried up (you can read more about how all this will affect you in this week’s MoneyWeek cover story – if you’re not already a subscriber, click here to get your first three issues free).
With official interest rates pretty much irrelevant, it looks like the Government is planning something much more dramatic. So far, Gordon Brown and Co. haven’t produced much apart from bluster. But today’s Telegraph reports on “radical Treasury plans” to take government stakes in the high street banks.
That’s called nationalisation. And when did that last work?
Our recommended article for today...
Where will the bail-out culture end?
- After guaranteeing all bank deposits for two years, Ireland is now seeing a healthy inflow of savers' cash. But if governments chase depositors' funds by backing banks with taxpayers' money, where will it all end?
Published in Economics
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by
David Stevenson
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