Prescience or Panic
09 / Nov / 2008
We all knew The Bank would cut Base Rate this month but even the most dovish of analysts thought a 1% reduction was the most the Committee would consider. As we set out last week, the arguments for aggressive action were overwhelming; a series of smaller cuts just wouldn’t provide the required stimulus. But why a 150 points? This action is aimed at restoring a measure of confidence to the consumer sector to counter the fast gathering clouds of recession. However, for roughly half of mortgages on fixed rates this will have no impact. Neither will it address the issue of inter-bank lending which, even with Government guarantees, is still weak.
Some analysts have described last week’s move as panic, an over-reaction which could persuade some market participants that the Bank, having moved too late in easing monetary policy, has lost it’s grip. This theory though ignores two key facts; the first is that the economy is weak and will weaken further – there will be worse statistics due in the coming weeks. The second is the lesson deriving from the Japanese experience of the 1990’s. An asset bubble running through the 1980’s convinced their banks to lend aggressively based on property values. When interest rates rose to counter a perceived inflationary threat the property market crashed leaving the banks with ravaged balance sheets and increasing “bad and doubtful” provisions. The result was that liquidity evaporated and consumers delayed purchases since paying later equalled paying less. The Japanese Central Bank cut rates slowly and cautiously in the face of high inflation numbers which masked the real paucity of economic activity. The problem for the UK now is that Government and monetary policy could lose all effectiveness if consumers convince themselves that the end of the financial world is nigh and even Base Rate at 0% would have no impact.
So what now? Another Base Rate cut in December cannot be ruled out but we feel that future reductions will be at the more usual 0.25% level. Not to reduce borrowing costs so much as to maintain the momentum of policy easing without clearing out the ammunition locker.