For days the expectation had been building that the Bank of England’s monetary
policy committee (MPC) would do something out of the ordinary. Since the
global financial crisis erupted into its deadliest phase in September, after
the bankruptcy of Lehman Brothers, MPC members had had only one chance to
respond to its sudden and damaging impact on Britain’s economy.
Early in October, Mervyn King, the Bank governor, had summoned the committee’s
external members a day earlier than usual, on the pretext of briefing them
about the government rescue package for the banks.
When they got to Threadneedle Street, though, it was to rubber stamp a
half-point reduction in Bank rate, coordinated with moves by the Federal
Reserve, European Central Bank and four other central banks.
Last Wednesday, when the MPC’s nine members gathered in the Bank’s first-floor
committee room, it was clear to them a repeat of that half-point reduction
would not be enough this time.
With a portrait of Montagu Norman gazing down on them - the governor who
steered the Bank through the Crash of 1929, the Great Depression and the
first few years of the second world war - the committee knew it had arrived
at a watershed.
In front of them were draft chapters of the Bank’s new inflation report, to be
published this week. Last month King had warned that the banking system had
come closer to meltdown than at any time in nearly 100 years and signalled
that the Bank would tear up its earlier forecasts.
Its last forecast, in August, predicting a “broadly flat” economy, had been
overtaken by events. Official figures for the third quarter showed a
bigger-than-expected 0.5% shrinkage in economic activity. Britain, he
conceded, was entering recession.
Since the governor has made clear in the past he has little time for the
traditional idea of a two-quarter “technical” recession, this week’s report
will not make pleasant reading - for the government or business. However, it
will also show a big drop in inflation, to below the official 2% target.
That, together with data, surveys and reports from the Bank’s own regional
agents, meant the cost of borrowing had to fall. The level of interest
rates, 4.5% ahead of the meeting, was too high. “Downside risks” had
increased sharply but upside risks to inflation and growth - the danger of a
sudden revival in spending - had evaporated. The only way for rates was down.
Committee members knew the MPC had never cut by more than half a point in its
11-year history. A bigger cut could smack of panic, undermine sterling and
signal a burying of the Bank’s “incremental” approach.
When King went round the conference table on Thursday morning to canvass the
MPC’s views, however, there was a consensus for a bigger, bolder move.
Moving slowly would bring accusations the Bank was “behind the curve” and
responding to events rather than leading them. This was one time the MPC had
to take a risk.
ON the crowded trading floor in the Broadgate headquarters of Icap, the
world’s biggest money broker, there was the usual buzz ahead of the Bank’s
rate announcement at noon on Thursday.
While most economists expected a half-point reduction, in line with the
pattern of MPC rate moves, some predicted the bigger, full-point cut being
demanded by business. The money markets were discounting a reduction of 0.75
percentage points.
When the announcement came of a 1.5 point cut, taking Bank rate from 4.5% to
3%, the lowest since 1955, “there was a stunned silence for a moment before
everything erupted”, said Don Smith at Icap.
“Even after the series of seismic shocks the markets have felt over the past
few months, and there have been plenty, the Bank managed to deliver another
one.”
Ross Walker of Royal Bank of Scotland described it as “extraordinary”, while
Stu-art Thomson of Resolution Asset Management said it was “shock and awe”.
The reaction was not confined to the City. David Smith was in his office in
Gaydon, Warwickshire, when he heard the news. “I was genuinely surprised.
And gratified,” he said.
Smith, who has been in his job as boss of Jaguar Land Rover, one of the
largest industrial employers in the Midlands, for only a few months, had
broken with the carmaker’s low-profile tradition ahead of the MPC meeting,
calling publicly for a sharp cut in rates and going on Radio 4’s Today
programme to make his case. He advocated a percentage-point cut, saying it
was necessary to stimulate consumer demand.
“Conditions in the car market are the worst we have ever seen," he
said. Jaguar Land Rover has laid off some workers, and will stop its
production lines for weeks over Christmas and new year.
Despite the grim outlook, the rate cut has buoyed Smith’s hopes. “We’ll have
to see what happens over the weekend to see if we get any kind of immediate
bounce. It is encouraging that MPC members have understood just how sharp
the downturn in consumer confidence has been.”
Other business leaders welcomed the move but acknowledged that it was in
response to the economy’s deep woes. Figures last week showed the longest
run of falling manufacturing output since the early 1980s, and the service
sector diving too.
Graeme Leach at the Institute of Directors said the Bank would need to go
further. “The sooner we get interest rates down the less is the risk of a
long and deep recession,” he said.
Andrew Semple, regional representative of the Engineering Employers’
Federation in northwest England, said the response to the cut was
bittersweet. “People welcomed the boldness of the Bank’s move but they also
wondered what lay behind it - what do they know that we don’t? Exporters
would also have liked more from Europe.”
The Bank’s move prompted speculation that the European Central Bank, meeting
in Frankfurt, would also slash rates. In the event, the ECB confined itself
to a half-point reduction to 3.25%.
FOR business, the Bank’s aggressive move raised two questions. Would it be
passed on, and would it work? By Thursday night just Lloyds TSB and Abbey
had passed on the rate cut and chancellor Alistair Darling’s patience was
starting to fray.
His officials started ringing the eight biggest lenders, Barclays, HBOS, HSBC,
Nationwide, Royal Bank of Scotland, Standard Chartered, Abbey and Lloyds
TSB, summoning their chief executives to a breakfast meeting at the Treasury
the next day.
Shortly after 8am, over bacon and sausage sandwiches, the bankers were told
they had a moral duty to pass on the cut.
“Alistair was firm,” said a Treasury adviser, who said the atmosphere was “a
little frosty, but businesslike”. “He repeatedly said that he expected rates
to be cut in line with the base rate - he was quite clear.”
Treasury officials saw the actions of the banks, some of which withdrew
mortgage products, while others dithered over what to do, as “pretty inept
PR”. The chancellor criticised Abbey, owned by Santander, for pushing up the
margin on tracker products earlier in the week and then trying to take
credit for “passing on the full rate cut”. Barclays argued that it always
“passes on” rate cuts to its mortgage customers, as 70% of its mortgage book
is in trackers.
However, the breakfast did the trick. By close of play on Friday, most lenders
had passed on the rate cut, though some insisted they had been unfairly
criticised.
They say the cost of their funds is not properly reflected by Bank rate, or
even three-month Libor, which dropped to just below 4.5% on Friday. With
wholesale markets a shadow of what they were, the banks are under pressure
to attract deposits, and that can be an expensive source of funding.
Even with lower rates feeding into the economy, the effect may be more muted
than in the past. Robert Barrie at Credit Suisse First Boston said the
combination of a low pound and low interest rates meant that monetary policy
was unusually loose. But he added: “The change in monetary conditions
probably needs to go further and it probably will.”
Tim Hastings, commercial director of a start-up healthcare technology
business, would certainly like to see monetary conditions ease. His bank is
threatening to reduce its lending facility even though the company has kept
up with payments and most of it has been guaranteed by the government
through the Small Firms Loan Guarantee scheme.
The firm has already lined up sales worth £235,000, expects turnover to reach
£1m in its first year, and plans to reach sales of £100m in five years.
Despite the company’s patented technology and strong prospects, the bank
will not back it, despite minimal exposure to losses.
“They have not sat down with us as a customer and asked us about our
market, our products, or our clients,” he said.
“They just don’t get the qualitative side. I spoke to someone in the bank who
told me they are in a panic and that even small lending decisions are being
signed off by the senior people.”
Last week’s big rate cut was welcomed by business. Most know, however, that it
will be no panacea. Additional reporting by Andrew Stone
Past interest-rate dramas
DRAMATIC RISES
September 16, 1992 On “Black” Wednesday, the government’s desperate
efforts to keep sterling in the European exchange-rate mechanism (ERM)
resulted in interest rates being raised from 10% to 12%, and then to 15%.
However, the attempt to keep the pound afloat failed and the rate hikes were
not, as is normal, implemented the following day. The Bank of England’s own
records now suggest they never happened.
May to November 1988 In May 1988, two months after a big tax-cutting
budget, the chancellor, Nigel Lawson, cut interest rates to a 10-year low of
7.5%. It did not last. Worries about inflation and the weakness of the pound
quickly forced rates higher. By November they were at 13% and boom began to
turn to bust.
November 15, 1979 After taking office in May 1979, Margaret Thatcher’s
government raised interest rates from 12% to 14%. But it failed to stop
inflation rising and the money supply ballooning out of control. On November
15, 1979 Bank rate was raised by three points to 17%.
DRAMATIC CUTS
March 10, 1981 In his budget speech Sir Geoffrey Howe announced a cut
in interest rates from 14% to 12%, alongside an “austerity” budget
that raised taxes. The lower rate did not last, however. By the autumn it
was back up to 15%.
October 1976 to October 1977 At the height of the International
Monetary Fund’s bailout of Britain’s economy in October 1976, Bank rate rose
to 15%, to get inflation down and to prop up the pound. But when inflation
began to fall and the pound strengthened, rates were cut aggressively. A
year later they stood at just 5%.
