The Bank of England has cut interest rates to by an unexpected one-and-a-half percentage points to the lowest rate in over half a century. Will it be enough to make the coming recession short and shallow?
Last month it cut rates from 5% to 4.5% in an emergency move co-ordinated with other central banks and it has now reduced rates even further to 3% which is the lowest rate since the mid 1950s.
There had been widespread calls from businesses for a major cut as the country begins to face up to the prospect of a deep recession but most had only anticipated a 1 percentage point cut at most and the first time the Bank has cut rates by more than half a percentage point since gaining its independence in 1997.
The move marks the Monetary Policy Committee’s (MPC) deep concern about the possibility of a prolonged recession in the UK taking precedence over concerns about inflation, which is currently running at 5%.
The cut will reduce repayments for those with tracker mortgages (40% of the total) by just under £90 per month on a £100,000 mortgage but there is no guarantee that lenders will pass on the reductions to those mortgage holders that are not on tracker rates. However, some banks e.g. Lloyds have promised to pass on the cuts even to their variable rate customers.
A series of recent figures have provided further evidence that the UK economy is in recession. House prices fell by another 2.2% in October according to the Halifax making a decrease of 13.7% over the past year.
According to the Chartered Institute of Purchase and Supply output from services was at its lowest level since started collecting figures in 1996.
The Office for National Statistics has announced that manufacturing output fell by 0.8% in September making output 2.3% lower than a year earlier, the sharpest decline since May 2003.
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Economists are now predicting that interest rates will fall further in 2009 as the recession bites. Some are even predicting they will fall to below 2% as fears of inflation are replaced by fears of deflation. To put that into context, interest rates have never been lower than 2% in the last 314 years since the Bank of England was first created.
The unexpected size of the current interest rate cut reflects Bank's concern over the rapidly deteriorating state of the UK economy with most commentators expecting growth between October and December to be as dire, if not worse than the last quarter (see earlier story).
Next year has been written off by all commentators and the only question is by how much the economy will shrink with 1% being the most common prediction. If growth resumes, even if only marginally, in 2010 then this recession will be less serious than those in the 1990s and 1970s during which GDP declined for two full years.
The 1990s recession was exacerbated by banks witholding lending to businesses. The scale of the credit squeeze in 2008 will almost certainly lead to an even worse situation as banks hoard cash. Unless they can be persuaded to adopt a more even-handed approach to business borrowing this recession will probably be long and deep regardless of any further interest rate reductions.
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