The Bank of England (BOE) cut the benchmark interest rate to the lowest since the central bank was founded in 1694 as policy makers tried to prevent the credit squeeze from deepening Britain’s recession.
The bank rate was reduced a half-point to 1.5 per cent, bringing policy makers closer to the point at which they will run out of options to fight the financial crisis with conventional tools. The pound rose against the euro and the dollar because some investors had bet on a larger reduction.
“They’ll come down below 1 per cent by the second quarter,” said Philip Shaw, chief economist at Investec Securities in London. “Things have deteriorated further and this highlights the need for further monetary stimulus. Non-conventional monetary policy techniques are on the cards.”
Bank of England Governor Mervyn King may have to cooperate with Prime Minister Gordon Brown to inject money into the economy and the financial system through the so-called quantitative easing as Britain suffers its first recession since 1991.
After almost 16 years of continuous growth, the economy contracted 0.6 per cent in the third quarter, and the Bank of England predicts it will shrink 1.3 per cent in 2009.
“The availability of credit to both households and businesses has tightened further, pointing to the need for further measures to increase the flow of lending to the non-financial sector,” the Bank of England said in a statement. “Output is likely to continue to fall sharply during the first part of this year.”
The pound climbed as much as 1.3 per cent against Europe’s single currency after the rate decision and traded at 90.44 pence per euro in London. Against the dollar, it increased as much as 1.2 per cent and traded at $1.5193.
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The central bank reduced the interest rate by 1.5 percentage points in November and by 1 percentage point in December.
The Bank of England may soon have to join the US Federal Reserve and the Bank of Japan in expanding its toolkit to fight the financial crisis. US officials, led by Fed Chairman Ben S Bernanke, lowered their main interest rate close to zero in December and on January 5 started buying mortgage-backed securities.
Rates in Japan are also close to zero and the central bank has increased its emphasis on adding funds to the financial system.
The European Central Bank has cut its key interest rate by 1.75 percentage points to 2.5 per cent since early October, and may reduce it again next week. President Jean-Claude Trichet may provide clues on his thinking when he gives a speech in Bratislava today.
Chancellor of the Exchequer Alistair Darling told the Financial Times this week that the UK Treasury may need to play a bigger role in setting monetary policy if interest rates approach zero. That may prompt the government to authorise the central bank to buy assets including government securities and perhaps create money to pay for them.
Darling today tried to damp speculation the government is ready to create money as part of a quantitative easing policy.
“Nobody is talking about printing money,” he told broadcasters today.
Financial institutions are hoarding cash and a Bank of England survey last week showed they plan to constrict credit further even after the government unveiled a 50 billion-pound ($75 billion) rescue plan last year. Mortgage approvals dropped to the lowest level since at least 1999 in November.
“We are fighting to do the right things,” Brown said today in Liverpool, northwest England, where he is holding his weekly Cabinet meeting. “The global banking system failed. We have got to rebuild it.”
“It’s baked in the cake that we’ve got higher unemployment coming, and that economic growth is likely to remain weak for a long time,” said George Buckley, chief UK economist at Deutsche Bank AG in London. The Bank of England “can still cut further.” The benchmark rate has never been this low since King William III founded the central bank to fund a war against Louis XIV’s France. The rate began at 6 per cent and fell no lower than 4 per cent throughout the 18th century.
It touched 2 per cent several times in the second half of the 19th century. The central bank held it at that level throughout World War II until 1951.
Unemployment rose at the fastest pace since 1991 in November and a survey released yesterday by the Recruitment and Employment Confederation and KPMG showed the number of workers placed in permanent jobs fell at the fastest pace since 1997 last month.
Barclays Plc, the U.K.’s third-biggest bank, said yesterday it will cut 408 information-technology jobs, primarily in London and Cheshire, England. Marks & Spencer Group Plc, Britain’s largest clothing retailer, said it will cut 1,230 of its staff.
Easing price pressures are giving the Bank of England scope to keep cutting interest rates. Inflation slowed to 4.1 percent in November from 4.5 percent the previous month. King predicted on Dec. 16 that the rate of annual price increases may drop below the 1 per cent lower limit this year.
“I’m not sure interest rates will necessarily get to zero,” said Matthew Sharratt, an economist at Bank of America Corp. in London. “We may see them at 0.5 per cent by the end of the first quarter. But now it’s really about what they do about quantitative easing.”