Belfast Telegraph

Tuesday 23 September 2014

Bank of England cuts interest rates to 0.5%

The Bank of England slashed interest rates to another record low of 0.5% today and launched an economic salvage bid with billions in newly-created money.

Official borrowing costs have fallen for the sixth month in a row, but the Bank will now tackle recession with so-called quantitative easing (QE) - effectively printing money - to ease credit conditions.



The Bank will create £75 billion to pump into the economy over the next three months.



Anxious banks are still reluctant to lend despite rates at all-time lows, so the Bank is resorting to increasing the money supply - which is uncharted territory for the MPC.



Bank of England Governor Mervyn King has asked Chancellor Alistair Darling for permission to create up to £150 billion to pump into the economy.



The MPC is worried rate cuts alone will not be enough to make a difference due to "depressed confidence and the persistent problems in international credit markets".



"Accordingly, the committee also resolved to undertake further monetary actions, with the aim of boosting the supply of money and credit," the Bank said.



Liberal Democrat Treasury spokesman Vince Cable said the Government should be wary of stoking up inflationary pressures for the future.



He said: "Today's rate cut means the Bank of England has now run out of conventional weapons to fight this recession.



"With interest rates now close to zero and the real threat of prolonged deflation and recession, the Bank's decision to start quantitative easing is understandable.



"Even with interest rates at a record low, the banking system is still in chaos with many families struggling to make ends meet.



"Directly increasing the amount of money flowing into the economy is now the only clear option.



"However, the Government must be careful that this kind of radical action doesn't quickly turn deflation into high inflation."



Mr King wrote to the Chancellor: "In these highly uncertain times, there are merits to stimulating the economy through a variety of different channels."



Ian McCafferty, the CBI business group's chief economist, welcomed the cut but said QE would have more impact.



He said: "The conventional rate cutting tool is becoming less and less effective as a means of stimulating the economy.



"A swift move towards quantitative easing as a way of boosting money supply and lending directly is now the MPC's best bet for supporting the economy and getting credit flowing again."



The Bank will create the money to buy Government and corporate bonds through its Asset Purchase Facility (APF).



The APF has bought up £820 million in corporate bonds - like company IOUs - in a bid to ease conditions in credit markets, but has so far been funded by £50 billion from the Treasury rather than "new" money.



Most of the £75 billion will be used initially to buy Government bonds. The MPC will now vote each month on what purchases are required as well as the level of official interest rates.



QE will only be used by the Bank of England to the extent necessary to hit its 2% inflation target.



Official inflation is currently well above target at 3.1%, but expected to plunge rapidly as recession grips and the Bank hopes boosting the money supply will ward off a prolonged slide into deflation.



Whether QE will work, however, depends on the extent to which struggling banks pass on the extra funds created by the Bank of England.



Today's move from the Bank comes against the grim backdrop of a deepening recession. Its own forecasts published last month predicted a year-on-year fall in output of almost 4% - although deputy Governor Charles Bean said the chances of an even heavier decline were odds-on.



This week has seen a fresh slew of downbeat data from manufacturing, services and construction sectors - while house prices are falling at a record annual rate of 17.7%, mortgage lender Halifax said today.



Royal Bank of Scotland underlined the problems in the ailing banking sector with a UK record £24.1 billion loss last week.



Meanwhile, around four million homeowners could see their monthly mortgage repayments drop as a result of the cut.



Roughly a third of mortgage customers have tracker loans, the majority of which will automatically move down in line with the Bank of England base rate.



But for those on other deals tied to standard variable rates, banks and building societies have argued that they are no longer able to pass on reductions in full as they have to balance the needs of their savers against those of their borrowers.



Shadow chancellor George Osborne said the Bank's move was "a leap in the dark".



Mr Osborne told BBC News: "Given that the Government's other measures have completely failed and the recession continues to get worse, this was a last resort.



"I don't think anyone should be pleased that we have reached this point. It is an admission of failure and carries considerable risk.



"Let us hope that this approach taken by the Bank of England does lead to an easing of credit conditions.



"This is a leap in the dark and we will see whether it works."



Shadow chancellor George Osborne said the Bank's move was "a leap in the dark".



Mr Osborne told BBC News: "Given that the Government's other measures have completely failed and the recession continues to get worse, this was a last resort.



"I don't think anyone should be pleased that we have reached this point. It is an admission of failure and carries considerable risk.



"Let us hope that this approach taken by the Bank of England does lead to an easing of credit conditions.



"This is a leap in the dark and we will see whether it works."



IHS Global Insight economist Howard Archer said the latest reduction to 0.5% was likely to see an end to rate cuts to ease pressure on bank profits.



He said: "Quantitative easing is clearly now going to be at the forefront in the Bank of England's ongoing efforts to stimulate the economy.



"Indeed, while we would not rule out a further cut ... we suspect that 0.5% will mark the floor, given the MPC's concerns about the negative repercussions that even lower interest rates might have on the banking sector."



Graeme Leach, chief economist at the Institute of Directors, said: "We strongly support quantitative easing and think it will be most effective if the Bank is aggressive in its use.



"Markets need to see a shock and awe approach over the coming months but even then there is no guarantee of success."

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