Bank gets radical with 1.5% interest rate cut

The Bank of England has shocked everyone by announcing a massive 1.5% cut in interest rates...

Last Updated: 31 Aug 2010

The Bank’s Monetary Policy Committee has taken the extreme measure of slashing rates to just 3%, after another raft of depressing statistics fuelled more gloom about the state of our economy. Although the MPC had been under increasing pressure to do something drastic, the debate seemed to be whether they’d cut by 0.5% and 1% - but Governor Mervyn King and co have proved to be a lot less conservative than everyone expected them to be.

The 1.5% cut is the biggest since 1981, and takes rates to their lowest level since 1955. In a statement, the Bank talked about the ‘most serious disruption [to the global banking system] for almost a century’ and suggested that the last few months had seen ‘a very marked deterioration in the outlook for economic activity at home and abroad’ – with a tightening of credit conditions, a fall in output, sliding equity prices (there were more big falls overnight and this morning) and declining confidence.

Today’s figures from the Halifax also highlighted the woes in the housing market: house prices fell by another 2.2% in October, so the average price is now 15% lower than it was a year ago – £168,176, to be precise, which is back down to October 2005 levels. Halifax’s chief economist did say there are signs the market is starting to stabilise (the number of approved mortgages was about the same as last month) – and the ratio of house prices to earnings has fallen below 5.0 for the first time since 2004. But with prices tumbling and mortgages still in short supply, it’s going to be a while before the market recovers any semblance of normality.

So there are plenty of reasons to cut rates – but in recent months, the threat of spiralling inflation has tied the MPC’s hands. However, the Bank said today that there had been a ‘substantial downward shift in the prospects for inflation’ (thanks largely to falling commodity prices), which had removed much of the downside risk. Clearly this made a big cut more palatable to a committee that’s tended to err on the side of caution (and to be fair, controlling inflation is its stated aim). Indeed, the MPC is now worried about inflation under-shooting its 2% target. If this is right – and after today we’ll soon see – we might see more cuts before long (indeed, former MPC member Prof. Charles Goodhart said on Channel 4 last week that the bank might end up having to reduce rates right down to zero, which would be pretty extraordinary).

The cut went down well with the market – the FTSE quickly recovered much of this morning’s losses, and even the pound is holding firm (for now) – although it is a clear sign of just how bad a state the economy is in. But at least a drop of this magnitude will have to mean reduced rates for borrowers – we suspect banks who don’t pass on at least some of this cut will rapidly be chased out of town...

In today's bulletin:

Bank gets radical with 1.5% interest rate cut
UK sales tumble, global car business hits brick wall
Eurostar shines bright at 2008 Green Business Awards
Federation of Small Businesses demands cut as bankruptcy fears mount
MT's Little Ray of Sunshine: Nice for Sir Tom 

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