Bank of England cuts interest rates by 150 basis points
06 Nov 08
Kevin Lings, economist at Standard Bank writes that the Bank of England decided
to cut rates by a massive 150bps today (Nov 6th). He says that the market was
expecting only a 50bps, although a few analysts had forecast a 100bps reduction.
No-one expected a cut of 150bps. Consumer inflation in the UK is currently up at 5.2%y/y, which is well above their target of 2%. However, the dramatic reduction in the oil price and other commodity prices suggests that inflation will fall sharply in the months and could well under-shoot the target. At the same time the economy is showing signs of weakness as consumer spending and house prices are down and some expect that the UK will not be able to avoid a severe economic recession.
The last time the UK cut rates by 150bps or more was in March 1981, when rates were cut by 200bps.
In making the decision the Bank of England made the following key points:
Since mid-September, the global banking system has experienced its most serious disruption for almost a century. While the measures taken on bank capital, funding and liquidity in several countries have begun to ease the situation, the availability of credit to households and businesses is likely to remain restricted for some time. As a consequence, money and credit conditions have tightened sharply.
Equity prices have fallen substantially in many countries.
In the United Kingdom, output fell sharply in the third quarter. Business surveys and reports by the Bank's regional Agents point to continued severe contraction in the near term.
Consumer spending has faltered in the face of a squeeze on household budgets and tighter credit.
Residential investment has fallen sharply and the prospects for business investment have weakened.
Economic conditions have also deteriorated in the UK's main export markets.
CPI inflation rose to 5.2% in September. The substantial rise since the beginning of the year largely reflects the impact of higher energy and food prices. But commodity prices have fallen sharply since mid-summer, with oil prices down by more than a half. Inflation should consequently soon drop back sharply, as the contribution from retail energy and food prices declines, notwithstanding the fall in sterling.
Salary growth has remained subdued. And measures of inflation expectations have fallen back.
In recent weeks, the risks to inflation have shifted decisively to the downside. As a consequence, the Committee has revised down its projected outlook for inflation which, at prevailing market interest rates, contains a substantial risk of undershooting the inflation target.
The European Central Bank (ECB) decided to cut rates by 50bps to 2.25%. This was in-line with market expectations. The ECB hiked interest rates by 25bps as recently as July 2008, but then cut in October as part of a global co-ordinated cut in rates. Overall, economic activity is slowing significantly in the Euro-area, with most economies expected to experience a recession in 2009. Consumer confidence has plummeted, retail sales are declining and growth in industrial production is slowing.
