Interest rates not cut but slashed by Bank of England

The BoE is seen to have taken decisive action by not concentrating on the level of rate cuts but by deciding on what level is appropriate for these unprecedented times, hence the record cuts! But with US rates at 1% and EU rates at 3.75%, has the UK taken the initiative again in world economics?

During this financial crisis the BoE has been finding credibility very hard to come across with our goals differing from our cross Atlantic counterparts. The BoE focus is fully on inflation, economic stimulus is second on the list, and this makes the latest rate cut even more interesting. Medium term inflation seems to be dipping just at the right time giving the BoE an excellent opportunity to assist our ailing economy where fiscal stimulus, from a once well respected chancellor, now prime minister, seems non existent.

Now that all the main lenders have passed on these full rate cuts the wider economy, from households to firms, the hope is to stimulate demand and supply now that mortgage and loan costs are considerably lower. It seems that this is step one in an aim to make sure that the UK does not hit a long hard recession the like that have crippled Japan. All the news is positive, we have targeted the original problem by making banks recapitalise and then aided the economy early and not waited before we are in the first recession for over 15 years.

However there are a few key issues. What does the Bank of England know that we don’t know? Have they reduced rates by such a steep margin because they are courageous and believe that now that have the appropriate market rates or is the economy outlook a lot worse than the market believes?

The further issue is that, yes, this rate cut will be stimulus to our economy but only in the short term. Remember the banks lending is all based on how easily they themselves can get credit and they do this based on Libor rates (London Interbank Offer Rates) which are still high. If these themselves do not come down then it is a vicious cycle where banks cannot get finance to in return give to the market. It seems the huge cut has solved a tiny slice of a massively entangled web of problems.

The next question persists is how much lower can rates go? 2%? 1%? Dare we even say 0%? The US is currently at 1% but they not only have different policy beliefs than us but acted quicker. If the UK were to approach 1% that would almost be check mate for monetary policy because the room for manoeuvre would be next to none. The Japanese have this problem, what effect did the 0.2% rate cut have? Very little if any! It would be a very tricky situation indeed.

On the other hand the European rates are higher standing at 3.75%. Have the EU got anything to be worried about. It does seem the economic slowdown is appearing to affect the EU less than UK and US, so are the rates appropriate? Or have the EU left it too late? In a world where globalisation is becoming more and more prominent it is amazing that the three most important economies on the planet have such different views on how to tackle this global recession. At this important time in the economic markets the Bank of England must believe that it has the better hand over the Federal Reserve and the European Central Bank!!!