Yesterday interest rates in the UK were slashed 1.5%, an unprecedented move which literally drew gasps of surprise from the City of London. At most perhaps 1% was expected.

Recapturing the initiative: The move was meant, the Bank claims, to be that decisive step in dragging the country out of the unfolding recession. But it seems that the investors were not impressed. UK shares continued falling on the day and the FTSE ended up 5.7% lower.

The Bank is seemingly trying to re-capture the initiative so that it is seen to be in control of the economy. It does not feel like it is in control, though, and the latest surprise interest rate cut feels like a knee-jerk reaction to events.

Economic outlook: UK interest rates have been quite high for some time and the Bank of England has been trying to micro-manage its inflation targets by fine-tuning its rates at 0.25% at a time. It lost track of the bigger picture long ago, being obsessed with inflation for way too long. Now the economy is shrinking, unemployment is on the rise, no-one is lending, no-one is spending, the markets are unstable and panicky and the financial system is in a mess. And they think they are going to be seen as leaders saving the day with a rate cut out of the blue? I don’t think so; too little, too late.

The rates should have been cut much earlier, then they could have had an impact when it mattered. That was at the latest at the start of 2008.

Retail banks’ response: One of the reasons this is not going to be an economic remedy that the Bank of England wants is to be is that retail banks are going to pass on as little of the rate cut as possible to their customers. Retail banks are in a big spot of bother themselves, needing to regroup after the credit crunch contraction set in and wiped out their balance sheets assets.

Being aggressive competetive profit-making organisation (= or fat cats as others will call them) that they are, they have no altruistic tendencies to help out consumers in need of cheaper credit – they are out to squeeze as much money as possible out of all of us.

We might argue it is socially irresponsible to act in this way when they ended the global economy in an unprecedented mess. But banks are exactly that – always have been – probably always will be – out for themselves. At best they will say they are serving their shareholders’ interests, although I have argued
before that often these are just lofty words of intent.

Yesterday’s interest rate cut will benefit banks which will now be able to secure cheaper credit for themselves at the time when credit is scarce. Banks are not going to willingly give all of this money away to its customers by correspondingly reducing their own lending rate and thus eliminating their chance of taking a profit, at the time when they are making losses on their past bad loans and derivatives transactions gone sour.

Lend me an umbrella: The confidence in making sensible lending decisions has been shattered by recent global events and it will take time for banks to start being cooperative once again. Remember the saying

“A bank is an institution that lends you an umbrella when the sun shines, only to take it away when it pours”.

We are seeing this process in action right now.

Low confidence is driving the recession: So if the government wants for retail banks to re-start lending, it is a bit like ordering the water to flow upstream. Lending policies are being drastically tightened, tolerance of customers in arrears is probably approaching zero, and rate cuts are not being passed on in a desperate bid to increase banks’ own profitability.

The promise of a recession is as ever becoming self-fulfilling, and we seem to have little control over this downward spiral at this stage – until we think we’ve gone far enough and confidence starts returning again.

 

Copyright 2008 by CuriouslyInspired

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