November 0.5% rate cut forecast

22 October 2008
The Bank of England is expected to announce another 0.5% interest rate cut as early as November amid the gloomy outlook for a recession in the UK.

The minutes from the central bank’s Monetary Policy Committee’s (MPC) October meeting - which saw interest rate cut 0.5% a day earlier than scheduled – show a unanimous vote for cut, unsurprising considering that central banks across the world also cut official interest rates that day in a bid to boost stockmarkets and ward off recession.

The minutes also show a gloomy outlook for the future; members of the MPC noted the seriousness of financial market turbulence warranted a half percentage point cut, despite inflation remaining well above its 2% target. Despite the official measure of inflation hitting 5.2% in September, experts now largely believe this has peaked as crude oil costs and food prices start to fall back.

At the time of the October cut, economists predicted more would be forthcoming, with the Bank of England base rate potentially falling to as low as 2% next year.

Now, many believe the next cut will come in the next interest rate meeting on 6 November – and will see interest rates fall from their current 4.5% level to 4%.

Vicky Redwood, UK economist at Capital Economics, says: “A November interest rate cut is therefore looking pretty certain, with a good chance that it is another 0.5%. After all, we have pointed out before that the MPC changed interest rates quickly, and a number of times, after the Asian crisis in 1998 and the 2001 terrorist attacks. And rates are likely to continue to drop sharply thereafter. We see rates getting to 2.5% or even lower next year.”

A gloomy speech by the governor of the Bank of England, Mervyn King, delivered yesterday (21 October) to the Confederation of British Industry, admitted just how close the British banking sector has been to collapsing, and hinted that further base rate cuts were necessary if not more important than capital injections in reviving the sector.

“I hope it is now understood that the provision of central bank liquidity, while essential to buy time, is not, and never could be, the solution to the banking crisis, nor to the problems of individual banks,” King said. “Central bank liquidity is sticking plaster, useful and important, but not a substitute for proper treatment.”

King added that he believes the corner has now been turned and the UK is now on the road to recovery – although the end of the road is still a long way off.

Ben Read, managing economist at the Centre for Economic Business Research, points out that in King’s speech, he mentioned the “R” word – recession – for the first time, admitting that it now seems likely that the UK economy is entering a recession.

Read explains: “King’s speech [indicated] a loosening of monetary policy […] Now the MPC is certain that the risks to inflation are on the downside at least we can hope to see aggressive cuts in base rates in the months ahead.”

Like Redwood, Read expects interest rates to be at least 0.5% lower before Christmas. However, he warns that consumers may not benefit.

“The big question is how much of these rate cuts will be passed on to consumers and businesses, as the impact of the UK and global banking rescue packages becomes clear over the coming months,” he adds.

Mortgage lenders have already come under fire for not passing interest rate cuts on to borrowers (read more here). Further interest rate cuts may also fail to benefit borrowers, as the cost of funding prevents banks and building societies from chopping their rates.

This Friday will see the quarter three’s GDP figures published, which are likely to show the UK economy has strayed into negative territory.

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