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King May Consider Most Radical BOE Cuts Since WWII (Update2)
By Brian Swint
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Nov. 6 (Bloomberg) – Bank of England Governor Mervyn King may have to consider the most radical round of interest-rate cuts since World War II as the financial crisis tears through Britain’s economy.
The central bank may need to lower its benchmark rate to zero from the current level of 4.5 percent, say economists including former policy maker Charles Goodhart and Citigroup Inc.'s Michael Saunders. The bank will probably move a step closer when it announces its next decision at noon in London, with economists expecting a cut of at least 50 basis points.
Rates will go down a long way,'' said Saunders, chief western European economist at Citigroup in London. They should be prepared to go to zero.‘’
The Bank of England’s main rate is still the highest among the Group of Seven nations even as evidence mounts that the economy has sunk into a recession. Manufacturing is in the worst slump since the early years of Margaret Thatcher’s government, house prices fell the most since 1991 last month and commercial banks are refusing to pass rate cuts on to consumers and businesses.
The Bank of England, which participated in an emergency reduction with six other central banks last month, will probably cut its benchmark to 4 percent today, said 45 of the 60 economists in a Bloomberg News survey.
Nine predict a cut of 1 percentage point and six said the bank will reduce by 75 basis points. The U.K.'s benchmark rate hasn’t been cut by more than 50 basis points since 1993, when the U.K. Treasury set monetary policy.
Zero Rates
Interest rates will go down from now on,'' Goodhart said in a Channel 4 television program broadcast Oct. 27. Quite how far and how fast I don’t know. They could go to zero. They went to zero in Japan in the 1990s when they had a recession or depression that went on for a long time and was quite severe.‘’
The Bank of England, founded in 1694 to finance King William III’s war against France, has never cut its key rate below 2 percent, keeping it at that level through World War II.
The European Central Bank will probably reduce its main rate by 50 basis points to 3.25 percent later today, said all but one of the 55 economists in a Bloomberg survey. The ECB’s decision is due 45 minute after the Bank of England’s.
The U.K.'s economy will probably be the worst performer in the G-7 next year, with the European Commission forecasting a contraction of 1 percent. The euro-region will grow 0.1 percent, the U.S. will contract 0.5 percent and Japan will shrink 0.4 percent, the Nov. 3 predictions show.
Rates Burden
Consumers and executives are also saddled with the highest rates, with the Bank of England’s benchmark comparing with the Federal Reserve’s 1 percent rate.
With our rate at 4.5 percent, it really is crazy,'' said Roger Bootle, founder of Capital Economics Ltd. in London. Rates have got to get down to around 1 percent, and they’ve got to stay there. I don’t rule out zero.‘’
The Fed’s interest-rate cut last week has helped bring down the rates at which banks lend to each other. The London interbank offered rate, or Libor, for three-month dollar loans fell to 2.51 percent yesterday from 4.82 percent on Oct. 10. The rate is still 151 basis points more than the Federal Reserve’s benchmark rate, compared with an average of 22 basis points in the five years before the global credit crisis began in August 2007.
Deteriorating Outlook
Reports this week have shown the U.K. economy’s downturn is worsening, prompting some economists to revise their forecasts for today’s decision and predict a bigger cut. Factory output dropped in September, extending the worst streak since 1980, the statistics office said yesterday. Services from banks to recruiters contracted the most since 1996.
Monetary easing needs to step up a gear'' after terrible’’ data, said George Buckley, an economist at Deutsche Bank AG, who had forecast a 50 basis-point cut. ``The escalation of the economic slowdown justifies, in our view, a full percentage point off interest rates.‘’
U.K. house prices fell 14.9 percent from a year earlier in October, HBOS Plc said today, the most since the index started in 1983. Property values, which tripled in a decade, will fall 30 percent from their October 2007 peak over three years, Fitch Ratings said yesterday.
Output Drops
The U.K. economy shrank 0.5 percent in the three months through October, the National Institute of Economic and Social Research said in a report today. Output is now lower than it was a year ago, the first annual drop since 1990, the report showed.
Slowing growth and plunging oil prices are also likely to push inflation, which accelerated to 5.2 percent in September, back toward the central bank’s 2 percent target. The Bank of England said in August that inflation could undershoot that goal in two years. The central bank publishes updated forecasts on Nov. 12 in its quarterly inflation report.
I don't think anybody believes this cut will be the end of it,'' said Saunders, who predicts rates will probably fall to 2 percent. The U.K. had one of the biggest credit and housing booms and the biggest drop in savings, so that makes us more exposed to the unwinding of it all.‘’
To contact the reporter on this story: Brian Swint in London at bswint@bloomberg.net.
Last Updated: November 6, 2008 04:34 EST
