The Bank of England was established in 1694. And in its history it has never set the official interest rate below 2%. Is the Bank going to create history by lowering the rates below their current 2 per cent for the first time ever?
Financial markets think so. Because they are dumping the Sterling in favour of Euro or Dollar, thus weakening the Sterling. This will make exports dear (not good for jobs), imports cheap (not good for economy) and also make foreign holidays expensive for millions of Brits (again, not good overall).
Any doubts against this historic event have also been dispelled by the recent events indicating that the British economy is sinking into deeper recession.
The purchasing managers of all major manufacturers said in a survey that they are not ordering much stock as they do not expect orders going forward as they fear wide job losses and therefore shrinking demand for their wares. The construction industry is in as poor shape as manufacturing.
We will be officially in recession soon as the GDP contracted by 0.5% in the third quarter and is expected to contract by 0.8% or 0.9% in the fourth quarter.
As the Bank of England reduced rates recently from 5% on October to 2% last month, attention has naturally focused on how these rates are helping (or not helping) the borrowers. Recent figures released for October show that although the home owners benefitted from rate cuts (although marginally), the actual cost of borrowing has risen for the private or non-financial companies.
In reality the lending to individuals and companies has virtually stalled since the summer. The desire among banks to lend is non existent as they appear just short of shutting doors in the face of borrowers at the moment (see illustration).
Why all this despite the best efforts by the government and Bank of England to keep things moving? The reason is clear: overextended banks are fearing big loan losses and trying to shrink their balance-sheets as fast as possible. In other words they are keeping hold of their money and calling back as much as possible to avoid themselves going under.
This obviously will make things difficult for struggling companies or even thousands of home owners trying to stop repossession of their homes. Not just that, this may even tip some good and credit worthy companies or individuals, temporarily finding themselves in the tight spot, to over the edge too. This is something the govt and the Bank of England is desperately trying to avoid.
And this is the precise reason why the Bank may have to cut the rates to below its historic ceiling for the first time ever. And then the government will have to make sure that banks and other lending institutions pass on the rate cuts to end consumers. Else we are facing a really serious recession.
After all these are the extraordinary times we live in!
Illustration curtsey: The Economist
Filed under: General
