Are 0% interest rates heading our way?

Percentage points

The Federal Reserve has slashed interest rates to nearly 0% in the US, prompting speculation that the Bank of England could take similar action here in light of rising unemployment and falling inflation.

The minutes from the Bank of England’s Monetary Policy Committee (MPC) interest rate meeting in December reveal that all nine members unanimously agreed to cut rates by 100 basis points to 2%. The minutes also show the members discussed an even bigger cut, although this was dismissed amid fears it could signal a lack of confidence in the economy and damage the value of the pound.

The MPC is due to next meet and vote on interest rates on 8 January 2009. Economists expect it to vote for another cut. In America, the Federal Reserve has now cut interest rates to a record low of between 0% and 0.25%. This is the 10th rate reduction in the US in 15 months. The cut gave a boost to shares in American companies, with the Dow Jones up 4.2%.

Jonathan Loynes, chief European economist at Capital Economics, says the minutes, along with the rise in unemployment, pave the way for the MPC to follow the US Fed and cut interest rates very close to zero.

“The minutes confirmed that all nine members voted for the 1% cut in rates to 2%,” he adds. “What’s more, they would have voted for an even bigger cut were it not for concerns that it would undermine confidence in the economy and prompt an ‘excessive’ fall in the exchange rate.

“At the very least, another cut in rates in January looks very likely and is unlikely to be the last.”

And Simon Denham, managing director at Capital Spreads, argues that falling prices and retail sales, rising unemployment and the economic downturn all support further rate cuts.

But with interest rates still not being passed on by banks to borrowers, it is unclear exactly how further cuts will help ease pressure on households.

Ben Read, managing economist at the Centre for Economics and Business Research, says: "No doubt the MPC will cut rates further in January, but it is likely more creative measures will be required by both the Treasury and the Bank of England."

The MPC agrees that the base rate it sets is not enough to get banks lending again to consumers and businesses.

The minutes state: “The Committee agreed that [the base rate] was not the right policy to tackle constraints in the credit market. Further measures to underpin lending growth would be needed, building on the government’s package announced in October to recapitalise and guarantee funding to the banks.”