Dramatic action looms as rates fall

Business flagged a growing prospect of direct action to boost money supply, and one economist declared "you can almost hear the printing presses being cranked up", as deepening recession triggered a half-point cut in UK base rates.

Economists polled yesterday by news agency Reuters attached a 40% probability to benchmark UK interest rates falling all the way to "near-zero" in coming months - based on their median response. The US Federal Reserve last month cut its benchmark interest rate to between zero and 0.25%.

UK base rates had not, before the cut announced at noon yesterday, been lower than 2% at any time since the Bank of England was created in 1694.

The Bank's Monetary Policy Committee has slashed base rates from 5% since early October, but there has been only limited pass-through to businesses and households by commercial banks and the availability of credit has continued to fall sharply.

Given this limited impact of base-rate cuts and the deepening UK recession, there is a growing view that the Treasury and Bank of England will be forced to boost money supply directly. Such "quantitative easing" might involve printing new money to purchase government bonds or other securities and thus boost banking sector liquidity - thereby promoting lending to businesses and individuals.

However, Chancellor Alistair Darling yesterday moved to quell rampant speculation that a move down the quantitative easing route could be imminent.

He said: "Nobody is talking about printing money. There's a debate to be had about what you do to support the economy as interest rates approach zero as they are in the United States. But, for us, that is an entirely hypothetical debate."

Stuart Porteous, head of group economics at Royal Bank of Scotland, appeared unconvinced by these comments. He said: "Few people - and certainly not the MPC - question the challenges the UK faces in 2009. As rates head towards zero, policymakers will be forced to embark on ever more un-orthodox measures to get the economy moving again. Listen carefully and you can almost hear the printing presses being cranked up."

Even at normal times, base rates take many months to feed through to economic activity. The MPC's statement which brought news of yesterday's cut in base rates acknowledged this time-lag by noting that the reductions implemented already would take effect "as the year progressed".

The MPC also highlighted the "unusually sharp and synchronised downturn" in the world economy.

Stephen Gifford, chief economist at accountancy firm Grant Thornton, described yesterday's base rate cut as "another major step intended to stimulate the economy out of recession". However, he declared: "The MPC's monthly cutting of rates to an all-time low has so far done little to get the economy back on track. It has provided some breathing space for some lucky borrowers with tracker rates but it has not had the desired effect on bank lending or helped consumers to start spending again.

"The Bank of England is now close to running out of options. If these latest cuts do not work, the only path left is for quantitative easing, where the Bank effectively prints money and uses this to buy up long-term assets in the market-place."

Gifford added: "Quantitative easing is a high-risk strategy riddled with economic, practical and political problems. There is the serious danger that inflation will rocket in two years' time, as policy-makers have very little experience of implementing this policy and will be unable to calibrate how much easing is appropriate. It will also undermine the independence of the Bank of England, as the government would have to work closely with the Bank to make this happen, fundamentally changing the function of the MPC."

David Kern, chief economist for the British Chambers of Commerce, described the economic outlook as "dire", and said the MPC "must act forcefully".

He added: "In order to ensure that the economy does not slide into a prolonged depression, we urge the MPC to reduce interest rates to almost zero in the next few months. It must also supplement lower interest rates with vigorous quantitative easing."

Liz Cameron, chief executive of Scottish Chambers of Commerce, said yesterday that she "would have liked to have seen a more bold approach by the Bank of England at the beginning of 2009" as she gave only a qualified welcome to the half-point cut. Cameron had wanted another full-point reduction, like that in December.

Ian McCafferty, the Confederation of British Industry's chief economic adviser, said yesterday: "Today's more modest interest-rate cut reflects the Bank's recognition that interest-rate reductions on their own cannot restore credit flows - the most important factor determining the prospects for the economy."

Edward Menashy, chief economist at stockbroker Charles Stanley, said: "Whilst the credit crunch continues to blunt the effectiveness of interest-rate reductions, the MPC will be tempted to follow the US Federal Reserve's example and pursue quantitative easing or policies which will increase the quantity of money in the economy through the purchase of a variety of assets."

Ed Monaghan, managing director of Scottish housebuilder Mactaggart & Mickel, welcomed yesterday's reduction in rates but said it was "now down to the banks to increase access to lending or the cut is meaningless".

He added: "Consumers' confidence has been knocked further with recent job losses, but the desire to move home remains, as well as a desperate shortage of new housing.

"The strength of the housing industry underpins the health of the whole economy. Those in the industry are doing all they can to encourage buyers with zero-deposit incentive packages and rent-to-buy schemes. The banks must now follow suit."

Howard Archer, chief UK economist at consultancy IHS Global Insight, said: "We expect the Bank of England to cut interest rates again in February and to bring them down to a low of 0.25% to 0.5% in the second quarter. Indeed, it is very possible that they could come all the way down to zero. In addition, it seems ever more likely that the Bank of England will engage in some form of quantitative easing over the coming months, in tandem with the Treasury."