View Full Version : BoE cuts interest rates to record-low 1.00%.

Feb 5, 2009, 09:18 AM
LINK (http://biz.yahoo.com/ap/090205/eu_europe_interest_rates.html)

Bank of England cuts, ECB holds steady

By George Frey and Pan Pylas, AP Business Writers

FRANKFURT (AP) -- The European Central Bank halted its campaign of rate cuts on Thursday, leaving its benchmark refinancing rate at 2 percent, while the Bank of England cut by a half-point to a record low 1 percent as it combats a deepening recession brought on by the world financial crisis.

The decision by both banks was widely expected but marked decidedly different approaches to the global economic woes that have sent markets plunging and led to thousands of layoffs, reduced worker hours and factory shutdowns.

The ECB, the central bank for the 16 countries that use the euro with their 330 million residents and gross domestic product of more than euro4 trillion ($5.6 trillion), has been more cautious than the Bank of England in cutting rates, which can stimulate growth by lowering borrowing costs for businesses and consumers.

But the rate-cut instrument relied on by central bankers has been blunted as banks struggling with losses from the financial crisis remain reluctant to loan or to fully pass on rate cuts.

ECB President Jean-Claude Trichet warned reporters at a press conference that he expected a steep decline in output when fourth quarter figures become available and that the economy will "continue to see weakness in the coming quarters" and that growth risks remain "to the downside."

He said the euro zone and its trading partners were still "experiencing a continuing significant downturn and that there is persistant weakness from the impact of the crisis on financial markets."

But he noted that inflation in the euro zone continued to fall last month because of a drop in commodity prices and weaker demand, a nod to the precipitous drop in oil prices.

Because of that, inflation could possibly reach "a very low level" by the middle of 2009. Lower inflation gives central banks more room to cut rates without fear of worsening prices rises.

He indicated rates could go lower in future meetings, saying two percent "is not the lowest level" that the ECB can foresee. But he suggested that the bank may not be heading for zero interest rates: "Zero rate doesn't seem appropriate to us at this time."

The bank's caution has led to criticism it is moving too slowly, raising the possibility that the recession in the euro zone could end up being worse than it would have otherwise been.

"The ECB is clearly behind the curve, as it was in July 2008, when it raised interest rates by a quarter of a percent," said Richard Snook, senior economist at the Centre for Economic and Business Research.

"Global policy rates at zero and coordinated quantitative easing across all major economies is the best remedy for an unprecedented global crisis," he said.

In London, the Bank of England cut rates as it tries to get the ailing British economy back on the rails. Official figures recently confirmed that Britain is experiencing its worst recession since the early 1980s. The economy saw output plummet by a steep 1.5 percent in the fourth quarter of 2008.

In its statement accompanying the decision, the Bank of England said business surveys indicated a "similar rate of decline" in the early part of 2009 as credit conditions continue to tighten for households and companies.

Even though annual inflation remains above the 2 percent target at 3.1 percent, the Bank of England said it expected inflation to fall below the target by the second half of the year as a result of waning retail, energy and food prices and the government's decision to cut sales taxes to 15 percent from December 2008.

However, the central bank said inflation rates may be "volatile" in the months ahead given the reduction in sales taxes and the fall in the pound, which has raised the cost of imports.

Though the Bank of England conceded that interest rate cuts have become less effective in stimulating the economy during the credit crisis, as banks hoard cash. But it did expect the sharp interest rate reductions enacted since October to have a "significant impact" on the economy eventually.

Since October, the Bank of England has reduced its benchmark rate from 5 percent.

More interest rate cuts are anticipated from the Bank of England in the coming months. It has also hinted that it may start to expand the money supply once interest rates fall to, or near, zero percent to avoid a bout of deflation -- a corrosive spiral of falling prices.

"The Bank now has to act to avoid deflation without fear of a further weakening of sterling; a weaker currency should serve to add to the competitiveness of exports," said Hetal Mehta, senior economic adviser to the Ernst & Young ITEM Club.