Rate cuts nearing Depression levels

By DAN ATKINSON FOR MAILONLINE
Updated:

A half-point cut in borrowing costs by the Bank of England is expected this week, taking the official interest rate to just one per cent - its lowest ever level.

Should the cut go ahead, it will mean the base rate will have fallen four percentage points in four months - one of the most aggressive series of rate cuts in British history.

Not since the Great Depression of the Thirties has the Bank produced reductions on anything approaching this scale.

The Bank of England has just announced more interest rate cuts

The Bank of England has just announced more interest rate cuts

The only comparable series of rate cuts in modern history was between February and June 1932, when the Bank reduced its official rate from six per cent to two per cent.

In normal times, a rate cut would be nowhere on the agenda of the Bank's nine-member Monetary Policy Committee.

Its job is to keep inflation, as measured by the Consumer Prices Index, at two per cent a year, and in the year to December CPI growth was running at 3.1 per cent.

But this rate is falling rapidly - it was 5.2 per cent in the year to September - and there are fears inflation could turn negative, with prices starting to fall.

Falling prices could prove just as damaging as high inflation, for a number of reasons.

First, because everybody would assume their money would go further in the future, they would hang on to it - thus depressing demand and sending prices down even further - the so-called deflationary spiral.

Second, deflation eats into earnings-Anyone in the private sector relies on prices of some sort to provide their income. When one falls, so does the other.

Third, while deflation eats into incomes it does not eat into debt. Earnings may shrink, but borrowings remain the same size. This bears down on economic activity, worsening the situation.

Shona Dobbie, head of research at Alliance, the investment trust, said: 'I would hope for another rate cut when the MPC meets on Wednesday and Thursday.

'It is not necessarily in the bag, but I would expect a cut of half a point. I do not think a quarter-point cut would have much impact.

'The only argument against doing it is that the cuts we have already seen do not appear to be doing much to get the economy going again, but they need all the pieces
in place in the hope that it will start to work.'

David Owen, analyst at German bank Dresdner Kleinwort, said: 'It is not a done deal but I expect them to cut by half a point. There is enough evidence of weakness in the economy, and these cuts do make a difference.

'For many households, they mean lower mortgage costs and for those companies that are able to borrow they mean cheaper loans.'

Ross Walker, economist at Royal Bank of Scotland, said: 'I expect a cut of 0.5 of a percentage point.

'Gross domestic product has been worse than expected and inflation is falling.

'There is no reason not to cut. But there is a slowing pace of rate cuts, not least because the Bank is running out of room.

He added that the Chartered Institute of Purchasing & Supply would produce two surveys of purchasing managers for January this week, one covering manufacturing coming out tomorrow and one for services on Wednesday.

'They will probably show more deterioration,' said Walker. 'But it may be that the pace of decline slows a little.'

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