The 150 basis point cut in interest rates was an audacious move by the Cenral Bank. It was three times as large as the European Central Bank's and was double markets expectation. Unfortunately, it is no cure-all remedy. At 3%, UK rates remain a full two points above US interest rates, with the UK economy in a debatably worse condition. British consumers are certainly more indebted. How has this central decision been reached?
The base rate of interest has significant effect upon borrowers and lenders and is crucial in guiding the economy. In my final year of secondary education I was fortunate enough to participate in the Bank of England's competition, Target 2.0, whereby one presents justification for the upcoming base rate decision in a team of four. In my humble opinion, with the current economic climate, Agents of the Central Bank will be listening more intensely to sixth formers solutions to the crisis, for a touch of youthful inspiration on monetary policy! The team I was competing in was only successful enough to reach the regional finals of the North West. Nonetheless, throughout the duration of the competition there was ample opportunity to converse on an informal level with peers, who shared interest in monetary policy, but more prominently, with employees of the Bank. Although they make up the panel of judges during your presentation and fire challenging questions at you, after the heat of battle, they were less intimidating, highly informative and dished out business cards to keen competitors. I decided to drop a speculative email to one of the Central Bank's Head Agents, whom I had met at the competition, requesting work experience. I was fortunate to be accommodated by North West Agency for an inside week.
During the week inside I drank numerous cups of tea and attended the meetings with the Agency's contacts. It was very much a one to one conversation but I was fortunate enough to involve myself in the discussions and provide my economic point of view to the contact and draw conclusions for the Agent. After meeting three contacts on a daily basis, reports are drawn up inside the office of the Agency and I was involved in producing the Excel spreadsheet consisting of the scoring for each business. In addition, the culmination of the exchange in business knowledge and number crunching is the final report, which is a confidential document that provides no indication of an individual business' performance, but gives an overview of the inflationary pressures being felt in the region. This report is then sent to the MPC for consideration of the base rate decision. Mervyn King had previously expressed 'this year we are probably facing a period of above target inflation and a marked slowdown in growth'. Although this seemed almost a certainty, my hope is that I did not exacerbate the situation!
As for the current rate cut, my savings are now incapable of outgunning inflation. We were told that the crunch was supposed to have been caused by borrowing too much money at too low a price. We were told the banks were facing a dilemma due to advancing loans as opposed to taking enough deposits. We were also informed that the typical bank needed to recapitalise to regain a balance between the two - more deposits whilst restricting lending. Is slashing rates really the solution? Inflation is at its highest in 17 years. The Bank may be short sighted in trusting the Keynesian notions of low interest rates that lifted us out of the Great Depression - 'spend your way out!' seems to be the cry as it was in the 1930's. Whether or not it is sound politics is debatable, lenders will not get overly excited by this supposed 'new credit' available; the day after the rate cut the FTSE fell further, high street banks are not risking more bad debts and are even reluctant to lend to one another. A spokesman for the Bank of England reported that inflationary expectations in the pipeline have been revised downwards and the risk was in a slowdown to the economy, associated with weak real income growth and the tightening in the supply of credit. Does this justify the biggest rate cut since the Bank gained independence? Confidence and credibility is running dry.