West Midlands is lukewarm over interest rate cut

Mar 6 2009 by John Cranage, Birmingham Post

News that the Bank of England had won Government approval to pump £75billion of new money into the economy while cutting interest rates to 0.5 per cent received a cautious reception in the West Midlands.

Concern focused on the fact that even though, up to midday yesterday, the official interest rate had been cut by four full percentage points, there was little or no sign of the benefits filtering down to cash-strapped companies.

One commentator, Tim Suffield of commercial property group Atisreal in Birmingham, warned that the country faced a “Japanese-style 15-year recession” unless the Bank and the Treasury recognise that demand is falling as banks and households rebuild their balance sheets.

Birmingham Forward chief executive Richard Brennan highlighted the need to rebuild confidence amid signs that the banks are still refusing to lend businesses the volumes they require to restore liquidity.

Louise Bennett, chief executive of Coventry and Warwickshire Chamber of Commerce, said the United Kingdom economy had moved into uncharted territory while money was still not flowing down from the banks.

The BoE, while cutting borrowing costs for the sixth month in a row, yesterday rolled out its new recession-busting policy of “quantitative easing” – increasing the supply of money in the system – in a last-ditch attempt to unfreeze the credit markets.

It will create £75billion to pump into the economy over the next three months and BoE governor Mervyn King has asked Chancellor Alistair Darling for permission for this to go as high as £150billion.

The Bank’s rate-setting monetary policy committee (MPC) is worried that not even the unprecedented rate cuts it has imposed will 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 yesterday.

Amid calls for a House of Commons debate on the Bank’s new QE tactic, Liberal Democrat Treasury spokesman Vince Cable said the Government should be wary of stoking up inflationary pressures for the future.

“Today’s rate cut means the Bank of England has now run out of conventional weapons to fight this recession,” he said.

“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 Confederation of British Industry’s business group’s chief economist, welcomed the cut but said QE would have more impact.

“The conventional rate-cutting tool is becoming less and less effective as a means of stimulating the economy,” he said. “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) which has bought up £820million in corporate bonds in a bid to ease conditions in credit markets, but has so far been funded by £50billion from the Treasury, rather than “new” money.

Most of the £75billion will be used initially to buy gilts. 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 two per cent inflation target. Official inflation is currently well above target at 3.1 per cent but is expected to fall rapidly as recession grips.

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

Shadow Chancellor George Osborne, who will be in Birmingham today , said the move was “a leap in the dark”.

“Given that the Government’s other measures have completely failed and the recession continues to get worse, this was a last resort,” he said.

Back in the West Midlands, business leaders were largely cautious. “The prospect of quantitative easing puts us all into a new situation and throws up new concerns,” said Peter Mathews , president of the Black Country Chamber of Commerce.

“The longer and deeper this recession is, the more businesses will suffer – even the previously low-risk ones, meaning the banks will have even more bad debts. If the banks are to receive more investment from the Bank of England, then we want to see it filtered through the system on to businesses immediately and the interest-rate cuts passed on to those who need it most urgently.”

Birmingham Chamber of Commerce and Industry, the biggest in the country, said business was “uneasy” with the fact that base rate is now at its lowest in the 315-year history of the BoE.

“At a time when stability is sought, this decision is bound to leave business nervous,” said policy adviser Will Rogers.

“Lowering rates has failed to stimulate the economy sufficiently and that means that the Government has no choice but to pursue alternative measures.”

The banks “simply must” pass on the extra money, Mr Rogers said, adding: “If they opt to hoard it with a view to solely rebuilding their own balance sheets, the economy will shrink further.”

Owen Trotter, of Key Capital Partners in Birmingham was unfazed by QE’s potential to stoke inflation. “Given the amount of debt held by the Government and corporate UK, inflation may be just what the doctor ordered,” he said.

Roughly the same message came from Chris Clifford, who heads the CBI in the West Midlands. “In the current economic circumstances, the risks of higher inflation...would be low,” he said.