Big interest rate cuts in Britain and Europe

By Ralph Boulton
Reuters
Thursday, November 6, 2008

http://www.reuters.com/article/newsOne/idUSTRE49N5VU20081106

LONDON -- Britain slashed borrowing costs by a surprising 1.5 percentage points on Thursday and the European Central Bank (ECB) also cut rates as part of concerted efforts to revive world commerce and ward off deep recession.

The ECB met market expectations by reducing its interest rate by 0.5 percentage point, a move political leaders hope will limit any move into recession and curb job losses.

The Bank of England, faced with a slumping housing market, a decline in manufacturing, and increased unemployment, astonished analysts by announcing a hefty 1.5 percentage point cut, the biggest since the Bank gained independence to set rates 11 years ago and a mark of the gravity of concern over the economy.

Heavy U.S. job losses, a sharp decline in the world services sector and bleak company outlooks painted an increasingly dark picture this week.

Matthew Sharratt, UK economist at Bank of America, echoed widespread sentiment in calling the British cut "astonishing." Jonathan Loynes of Capital Economics called it "spectacular."

"There is still more to do," Loynes said. "At 3 percent, UK interest rates are still well above U.S. ones when economic conditions suggest they should be as low if not lower. ... Our view remains that UK rates will fall to 1 percent or below."

Last month the Bank of England joined forces with the U.S. Federal Reserve and European Central Bank to make an emergency half-point cut in interest rates. Politicians in the 15-country euro zone hope a rate cut from the ECB, possibly half a point, will help stave off recession and limit unemployment.

The ECB move took its benchmark rate to 3.25 percent.

The 15-nation euro zone's economy, which had grown steadily since the bloc's creation in 1999, contracted by 0.2 percent in the second quarter this year and most economists expect further shrinkage in third quarter GDP figures on November 14.

Rate cuts may be less effective than in the past.

Banks infected by a collapse of confidence within the financial system are still wary of extending loans and are reluctant to pass cuts on to borrowers. But the sheer scale of Thursday's cut will put pressure on British banks to conform and back smaller businesses, some facing bankruptcy.

The Swiss national bank cut its rates by 50 basis points.

Markets looked to U.S. President-elect Barack Obama to name key members of an economic team that must tackle a crisis that originated in the U.S. housing market 15 months ago before enveloping the banking system and threatening the very foundations of the global market economy.

"After the world rally on the day of the presidential election, investors have now shifted their focus to how fast, and how well the new administration will address the current economic issues," said Yoo Soo-min, analyst at Hyundai Securities.

Toyota Motor Corp., the world's biggest automaker, slashed its annual operating profit forecast by more than half and its shares tumbled over 10 percent, making it the latest casualty in an industry hit hard by the slump. Goldman Sachs Group Inc was laying off 3,200 employees this week, according to sources familiar with the situation.

European stocks and Britain's FTSE 100 index briefly pared losses after the British move before falling back again to trade around three percent down.

U.S. crude oil lost 2 percent to $63.96 a barrel, against a record high above $147 set in July. The fall, reflecting expectations a global recession, will reduce inflationary pressure on national economies and ease rate cuts.

Falling world oil prices and ebbing economic activity have effectively banished fears of inflation that dominated policy thinking only a year ago.

Obama's landslide win on Tuesday, along with the Democrats' tighter grip on Congress, raised hopes of a speedier injection of billions of dollars to shore up the struggling economy.

The first black U.S. president has to wait until January 20 to move into the White House. In the meantime, though, he must decide on a successor for Treasury Secretary Henry Paulson, one of the architects of a $700 billion state rescue package inconceivable before the crisis broke.

Timothy Geithner, president of the Federal Reserve Bank of New York, former Treasury Secretary Lawrence Summers, and former Fed Chairman Paul Volcker are among those mooted for the Treasury post. Obama may announce his pick on Thursday.

The slump is already encroaching on Main Street. World number two sporting goods maker Adidas stood by its 2008 forecasts, but retracted targets for next year, declaring that conditions were too difficult to predict.

A Swedish central bank official said the shape of a Nordic aid package to crisis-hit Iceland had been decided. Norway said earlier this week it would provide Iceland with a 500 million euro ($643 million) loan to help the country rebuild an economy in tatters following the collapse of its biggest banks.

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