Why Another Rate Cut by the Bank of England Won’t Help

The Bank of England’s (BoE) Monetary Policy Committee meets on Thursday to discuss interest rates, amid calls for the base rate to be cut from 0.5 percent to 0.25 percent. This follows second-quarter GDP numbers last week which showed that the U.K. has suffered three successive quarters of contracting economic output.

London Financial District
Photo: Vulture Labs | Getty Images
London Financial District

Are the economy’s ongoing troubles really due to the level of interest rates? Is it a high cost of borrowing that is stopping recovery? The current base interest rate, in place since March 2009, is the lowest in the entire history of the Bank.

The BoE just announced an increase in quantitative easing (QE), up to £375 billion. It now holds one-third of the entire U.K. government bond market. Is the continuing recession problem going to be fixed with even more extreme monetary policy?

If the answer to this question is yes, why stop there? Why not cut rates to zero percent and increase QE to £500 billion or even £800 billion? The BoE can fund the country’s entire public debt, simply by creating cash at the click of a mouse.

Interest rates for mortgages, car loans, corporate loans and overdrafts are lower than they were during the bull market and the first recession in 2008-09. They are at historic lows now. They are expected to remain at historic lows for the next two years at least.

Yet that isn’t motivating people to take out fixed rate loans – why bother when one can take out a floating rate loan in the knowledge that rates will stay low for some time yet?

This is no longer a monetary policy issue. It isn’t the cost of borrowing that is stopping investment and capital projects in the corporate sector, any more than it is stopping activity in the housing market. It’s the uncertainty about the future, the lack of confidence, the fear of unemployment.

More QE will not make a lot of difference to these things, just as a base rate of 0.25 percent won’t.

We need to incentivise companies to hire staff, we need to make it easier to do business, we need to tackle all the supply side and labour market issues that are acting as a drag on growth.

And if it was at all possible, we need to subtly give the hint that rates will not be going any lower, not because we’re masochists but because we realise it won’t make any difference to economic activity and will have a negative impact on savers and pension funds.

Who knows, if the corporate and retail market knew that the next move in interest rates was going to be up, they might even rush out quicker and start taking out those long term fixed rate loans. At least that would add to economic activity.

Professor Moorad Choudhry is Treasurer, Corporate Banking Division, Royal Bank of Scotland.

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