NYTimes:European Banks Cut Rates Sharply
Posted November 6, 2008on:
Two central banks in Europe cut their benchmark lending rates on Thursday for the second time in less than a month as they tried to stimulate their decelerating economies.
The Bank of England unexpectedly reduced its benchmark rate by 1.5 percentage points, its biggest rate reduction in more than a decade, and the European Central Bank lowered its interest rate as expected by half a percentage point to 3.25 percent.
The Bank of England cut was to 3 percent, the lowest level since 1954, surprising investors and economists who had predicted a cut of half a percentage point.
“Central banks don’t cut for free; they do so for very real economic risks,” said Philip Isherwood, a strategist at Dresdner Kleinwort in London. “We’re going back to the early 1980s when we also had coinciding recessions around the world.”
Both banks cut their rates by a half percentage point on Oct. 8 in a coordinated response with other central banks around the world as they tried to loosen credit markets.
“It gives an indication of how strong the central bankers think they must act now,” said Richard Hunter, a fund manager at Hargreaves Lansdown in London.
In comments after the rate decision, the president of the European Central Bank, Jean-Claude Trichet, would not rule out a future rate cut, saying the financial turmoil was likely to dampen demand “for a rather protracted period of time.”
At the same time, Mr. Trichet said, “Inflation rates are expected to continue to decline in the coming months, reaching a level in line with price stability during the course of 2009.”
He said that given all of the recent actions to ease the financial turmoil, it was important for everyone involved to “live up to their responsibilities,” singling out banks.
“We expect the banking sector to make its contribution to restore confidence,” he said. Despite infusions and financial guarantees from governments, banks have been reluctant to start lending again.
The Bank of England’s large cut shows the bank’s readiness to take drastic steps to cushion the effects of what is likely to become the worst downturn in 17 years as stock markets and house prices slump and consumer confidence drops while banks refrain from lending.
“The Bank of England’s historic decision to cut base rates by 150 basis points today is a measure of how sharply economic conditions have deteriorated since the summer,” said Stuart Thomson of Resolution Asset Management in Glasgow. “The rate cut was aggressive and necessary and we believe that base rates will fall further over the next two years as the economy flirts with deflation.”
Two other European banks also acted Thursday. The Swiss National Bank cut its key interest rate by half a percentage point to 2 percent, and the Czech Republic’s central bank cut its rate by three-quarter percentage point to 2.75 percent.
Stock markets fell Thursday in Europe and Asia as investors feared the slowdown would hurt companies’ earnings. Some economists said the deteriorating outlook made Thursday’s cuts a necessity rather than a tool to cushion the blow for investors and consumers.
“Funding is still expensive so the effect of a rate cut on the economy will be diluted,” said Alan Clarke, an economist at BNP Paribas in London.
Britain’s government put pressure on banks to pass on the interest rate cuts to their customers and step up lending to small businesses, but its demands were met with resistance as interbank lending rates remained relatively high and banks were increasingly concerned about rising loan default rates.
European governments increased their aid packages for consumers this week as well. Germany’s cabinet passed a plan to spend 50 billion euros, or $64 billion, on tax breaks and infrastructure investments, and Spain, which has the European Union’s highest unemployment rate, is allowing unemployed homeowners to defer mortgage payments. The Italian government plans to announce its own bank bailout package next week.
The recent cuts by the European Central Bank are a stark contrast to just three months ago when it raised rates, saying inflation was a bigger threat than an economic slowdown. Since then, inflation slowed while the region’s manufacturing and service industries shrank and consumer confidence dropped to the lowest level in 15 years.
The region sharing the euro as a common currency may grow 0.1 percent, according to a European Commission forecast in November, while the British economy will shrink 1 percent next year, America will shrink 0.5 percent and Japan will contract 0.4 percent.
In Britain, a decline in factory production and a slump in service sector activity in September painted the grimmest economic picture since the last recession in the early 1990s, prompting some economists to suggest the Bank of England might have to reduce rates to zero.
British factory production fell 0.8 percent in September from August, a seventh consecutive decline, making it the longest uninterrupted drop in 28 years. The Chartered Institute of Purchasing and Supply’s index of services fell to 42.4, from 46 in September, the lowest level since the index started 12 years ago. Britain’s economy shrank 0.5 percent in the third quarter in what many economists predict to be a recession that may last as much as three years.
Britain’s economy is more exposed than others in Europe because of its relatively large public debt, highly leveraged banks and dependence on the financial services industry as well as a housing boom that led to almost two decades of uninterrupted growth. House prices in Britain fell 14.9 percent in October compared with a year earlier, the biggest decline since at least 1983, when the mortgage lender HBOS started to track the numbers.