I was absolutely astounded by the Monetary Policy Committee’s decision to cut the Bank Rate from 4.5% to 3% at its latest meeting. Even though I had been making the case for a 1% cut I had really only expected the Bank to cut ½%. When I first heard it, I thought there had been dreadful mistake! But, sure enough, the Bank had cut interest rates by a quite unprecedented 1 ½% and the markets, on the whole, took it in their stride.
Looking back to Mervyn King’s speech to the businesspeople of Leeds on 21 October it was quite obvious that he was worried about the state of the economy. His gloomy recession-laden remarks promptly drove the pound down. By the end of that week, the third quarter GDP figure was released which showed a far-worse-than-expected fall of ½% in the quarter. And just about all the news since then has marked further deteriorations in the economic climate. Unemployment and short-time working are rising and confidence is falling. The exception to this generalisation is that oil and other commodity prices remain subdued and inflationary pressures are melting like the snow in October. A good dose of monetary easing was definitely in order.
It is, of course, most unlikely that the full 1 ½% cut will be passed on by the lenders to people with mortgages or small firms with bank loans. The inter-bank market is still not functioning normally, LIBOR has trickled down at a glacial pace since its recent peak in the week of the great financial panic in early October, and many lenders are nursing damaged balance sheets. But some of the Bank’s cut will be passed on and this will help borrowers and encourage lending and, hence, alleviate the worst effects of the recession. But it cannot avert recession.
In comparison with the headline “shock and awe” tactics of the Old Lady, the European Central Bank’s decision was a staid affair – just ½% down to 3¼%. But perhaps this isn’t altogether too surprising. It is all too often forgotten that there is a key “economico-cultural” difference between the Anglo-Saxon economies (US, UK, Australia, New Zealand and Canada) and the core European economies. As the credit crisis has dramatically demonstrated, in the Anglo-Saxon economies it is the overall availability and cost of credit to both businesses and consumers that impacts on the real economy. British consumers, for example, have been only too enthusiastic in their uptake of credit (well, it’s really “debt”) to fund their lifestyles and stimulate the economy in the “boom” times – with nasty consequences in the “busts”. In core Europe the key to the impact on the real economy is the availability and cost of credit to businesses. For consumers, savings rates are actually more important in their economic decisions. And, by extension, dramatic cuts in interest rates in core Europe could, therefore, actually suppress consumer spending.
Sharp cuts in rates, therefore, are much more positive for an Anglo-Saxon economy than a core European one. This fundamental economico-cultural difference is one of the key reasons why it would be difficult for the UK to adopt the euro. And we should keep reminding ourselves of this, if/when the debate on UK membership of the euro ever regains serious traction.
