Friday, February 06, 2009

Bank of England Cuts Benchmark Rate as Britain Sinks Deeper into Recession

Sources: Bloomberg, U.K. Will Shrink Until Fourth Quarter, Nieser Says; Bloomberg, Bank of England Cuts Main Rate a Half Point to 1%; Washington Post, British Central Bank Lowers Its Interest Rate to 1 Percent; Bloomberg, U.K. Manufacturing Contracts, Insolvencies Rise in Recession

The Bank of England has lowered the benchmark interest rate to one percent, the lowest since it was founded in 1694, to aid in the fight against recession. According to the IMF's forecasts, the UK's economy will be the fastest shrinking economy in the developed world this year, and the National Institute of Economic and Social Research predicts a 2.7% drop in the UK's gross domestic product. The cut in the benchmark rate is intended to alleviate frozen credit markets, which have been hit hard in the UK and suffer from low investor confidence.

British service industries are in particular trouble, and up to five thousand British companies may file for bankruptcy this year. Manufacturing contracted in January for the tenth month in a row. Banks such as HSBC are planning to pass the rate cut onto their mortgage and small business customers. Even so, many small businesses are unaffected by the rate cut because they cannot access loans.

In addition to rate cuts, the government has given the central bank authority to spend up to $73 billion on bonds and commercial paper. Tax cuts, the falling value of the pound, and falling commodity prices will provide a stimulus to the British economy, but credit conditions are still tight. Inflation is likely to fall below a target of 2%, and house prices are also falling.

Britain is not alone in the rate-cut strategy. The U.S. Federal Reserve has reduced its key rate to a range between zero and a quarter of a percent, and the European Central Bank is holding at two percent but may cut the rate in March. Other countries cutting rates on Thursday include South Africa and the Czech Republic. However, some analysts feel that the strategy is insufficient considering the extent of the UK's recession, and that the government and the central bank should consider other suggestions such as buying up corporate debt.

1) Do you think the rate cut strategy is a wise policy, or are other measures needed to slow the recession in Britain?
2) Do you agree that the stimulus provided by factors such as tax cuts and falling commodity prices will be enough to significantly affect the course of the recession?

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