Bank of England Could Drop Rates to Zero

The United Kingdom economy contracted the most since 1980 in the fourth quarter of 2008 as the financial crisis ceased consumer spending and companies stop investing. Has the Bank of England used all available measures to boost the credit? What else can be done to stop the downturn spiral?

Since October, the Bank of England has cut its benchmark interest rate by an unprecedented 4 percentage points and we expect the benchmark interest rate to be reduced by at least 25 basis points on March 5. However, lower interest rates may offer very limited benefits. Indeed, banks are not likely to lend yet as they need to repair their overstretched balance-sheets. Moreover, there is another danger around the corner if overnight rates reach zero, the BoE deposit facility and the overnight rate will offer the same rate. Under those circumstances, the interbank market may fade away even more with banks depositing excess funds at the BoE rather than in the money market. In addition, deposit rates at zero may squeeze bank profits and wear down an already scarce bank capital.

Looking ahead, in the opinion of Trading Economics, the only hope to stabilize the British financial market may be quantitative easing. So, we expect the Bank of England to start pumping more money into the economy within next few weeks by purchasing government and corporate debt which will boost the overall money supply and stimulate borrowing and spending.

Anna Fedec,
2/27/2009 2:37:07 PM