No change in interest rates for the rest of 2009?

There will be no change in interest rates before next year, the Austrian member of the ECB Governing Council said yesterday. "While there are first signs that the pace of economic weakening is decelerating, we must remain alert. Banks know the ECB is following a policy of the steady hand, so they don't expect rapid changes in the interest rate. And I think banks more or less also share our expectations regarding the economic outlook."

The unusually clear statement from Bank of Austria Governor Ewald Nowotny backed up a similar message from ECB President Jean-Claude Trichet in more careful tones, as the ECB official said the bank was likely to keep interest rates steady for at least the rest of the year. "We are in uncharted waters, and there are still risks of a sudden emergence of unexpected financial turbulence," Mr Trichet said at a weekend conference in Madrid.

The Bank of England to start 'quantitative easing'?

The Bank of England is expected to reduce interest rates to yet another record low tomorrow lunchtime; but with their rate-cutting ammunition all but exhausted, they are expected to press the button on a much more drastic policy — quantitative easing. As the recession deepens, weakening wage growth, plunging oil prices and consumer demand are threatening to drag inflation well below the Bank's 2% target.

With interest rates already at a historic low of just 1%, the monetary policy committee (MPC) believes further cuts will not be enough to kick-start the economy. Quantitative easing is popularly known as "printing money," but it doesn't actually involve turning on the presses. It actually means that the Bank will buy billions of pounds of assets, usually government bonds, from cash-strapped banks, in the hope that they will push the money back out again in loans to the public. In recent years the tool has been used by Japan to stimulate their economy and to fight inflation. Much of the global economic crisis is caused by frozen credit markets. Many companies find themselves unable to secure loans necessary for day to day operations. The credit crunch has adversely affected the interbank market - meaning banks have been unwilling to lend to each other.

Increased disposable income to go into savings?

David Smith, Economics Editor with the Sunday Times has a well written article today dealing with how the reduction in interest rates amongst other factors will mean an increase in consumers' disposable income - which people will save rather than spend.
(I have abridged the article slightly).

Wandering round Poundland, as one does, is a bit different from the rarefied atmosphere of Davos but is an experience to be recommended. In this Aladdin's cave, which has everything from the latest Rupert annual, six-packs of rare incandescent light bulbs and mini tool kits to household goods, toiletries and non-perishable foods, there is a sense of wonder that anybody can make this stuff for £1, let alone sell it.

The Poundland effect underlines how tough things are for higher-priced retailers, which is why it is expanding while many of them are shrinking. That, however, is not the only message. Just down the road is a 99p shop and, unless my eyes were deceiving me, it was busier. To economists, if not to Poundland, that is gratifying. It shows price signals work, even at low prices and that the fashionable "left digit effect" is alive and well.

This is the effect that makes us more likely to buy at £9.99 than £10. By the same token, 99p is more appealing than £1. I am tempted to open a 98p shop, though experts say that to make a real difference you might have to go to 89p, if not 49p. The real point is that one of the stories of 2009 will be that consumers can buy cheaply, if they choose to, and not just at the discounters. We are moving into a period where inflation will be negligible, and for periods negative, in spite of sterling's fall.

This, and what will be a very gloomy economic forecast, prompted the Bank to cut interest rates from 1.5% to 1%. As I wrote last week, I would not have done so at this time. But how strange it is that such low rates have become almost commonplace. Low rates are providing a bonus for borrowers, bringing big reductions in mortgage payments. More generally, low inflation — helped by the government's temporary Vat cut — will provide a boost to real income growth. Just how big was underlined by the National Institute of Economic and Social Research in its latest review.

It predicts real household disposable income will jump 3.3% this year, well up on last year's increase of 1.5% and 2007's zero growth. If this is right, it will be the best year for income growth since 2001. We will not have had it so good for a long time. The question is: what will people do with it? Simon Kirby and Ray Barrell, economists at the institute, are pretty sure they will not spend it. Alongside that 3.3% rise in incomes they predict a 3.8% slump in consumer spending. Saving, not spending, will be the watchword this year, they say, with the saving ratio predicted to jump from 1.3% last year to 7.1% this year.

It is an interesting forecast and a brave one. Lots of unprecedented things are happening but that would be an unprecedented divergence between income growth and spending. Barrell points out that something similar happened in the early 1990s, but spread over three years. This time, he said, the effects were coming through much quicker, with falling housing wealth and lack of availability of credit being the two main factors pushing spending lower.

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Surely, you will say, this recession is all about households deleveraging — paying off debt — and a sharp drop in consumer spending will be a natural consequence of that. But, as I have pointed out before, consumer spending has been rising at a slower rate in recent years and was, in any case, mainly financed out of income growth.

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There will be a two-way debt battle in the coming months, rising unemployment making it hard for a minority to service their home loans, while lower interest rates will make it easier for the majority.

Where will this leave spending? Nationwide's consumer confidence index is at a record low, though the proportion of people saying now is a good time for a big purchase has risen again. That is important. Official figures show retail sales held up pretty well through to the end of last year, but that spending on big-ticket items was very weak. Ask any car dealer.

In the end, confidence is the key. Consumer recessions are not caused by people cutting back who have to. They happen when those who are not badly squeezed decide it is prudent not to spend. This is Keynes's paradox of thrift; we would like a higher level of savings but not right now.

It could go either way. But if the institute is right in its calculation of the rise in real incomes this year, I would be quite surprised if it is also right on spending.

Full article

US interest rates now virtually at zero

The US Federal Reserve has tonight slashed its key interest rate from 1% to a range of between zero and 0.25% as it battles the country's recession. Wall Street shares soared after the Fed, the powerful US central bank, stunned markets by cutting interest rates from an already 50-year low of 1% to virtually nothing. In its statement, the Federal Reserve predicted that rates would stay at the current exceptionally low levels "for some time". It added that it was considering ways it could spend money on supporting the economy and credit markets. Analysts said that the key rate is now virtually zero. "Whether it's zero or 0.25% actually does not make a huge difference," said Holger Schmieding at Bank of America. He added that the more important factor is what policymakers plan to do now that they cannot cut interest rates any further.

The Federal Reserve stressed that it was already planning to buy large quantities of additional debt based on mortgages and is considering whether it would be a good idea to buy long-term US government bonds. The strategy of a central bank buying government bonds mirrors the so-called 'quantitative easing' carried out by the Japanese government when it was fighting deflation in the late 1990s and early 2000s.

What is 'Quantitative Easing'?

Most nations are now reducing interest rates at a phenomenal rate to stimulate their economies and counteract a recession they are either in or are sliding towards. But what will happen if/when rates reaches 0%? What will they do then? One option is to actually break through the zero percent barrier and introduce a negative interest rate - which would basically be a tax on bank deposits. Perhaps savers would withdraw their deposits and spend them, however, it is probably more likely savers would withdraw the deposits and hoard their cash at home - thus reducing banks' liquidity. To counteract this, banknotes may even end up having 'best before dates' printed on them after which time they are deemed worthless! Thus forcing people to spend.

A different option which could be used to maintain interest rates at 0% is 'quantitative easing'. It is a monetary policy tool, which means the central bank prints new money, in order to increase the money supply. 'Quantitative' refers to the money supply; 'easing' essentially means increasing. So, the central bank floods the market with cash in an attempt to stimulate an economy in recession and, importantly for 2009, to stave off deflation. The idea is that if the central bank floods enough cash into the market, it will set off the following chain of events:

1. Banks and other financial institutions will build up larger and larger cash reserves.

2. Banks will finally decide to loosen their lending standards to utilize their excess cash.

3. Individuals and companies will start getting the loans they are seeking.

4. The economy will begin to recover as people and companies begin to spend again.

Quantitative easing was used notably by the Bank of Japan to fight domestic deflation in the early 2000s after its property and stock bubble bursts. It was a groundbreaking experiment and took a long time to work because the Bank of Japan was slow to employ all of its policy options and spell out its goals in a credible fashion. In recent weeks, both Ben Bernanke, Chairman, the US Federal Reserve, and British PM, Gordon Brown, have hinted at employing different monetary policies in the near futre for their respective economies. However, it should be noted, despite the almost certainty now that many Western economies will face deflation next year, the inherent danger of flooding the economy with cash can be very high inflation in the longer term. In fact, 95% of all historic cases of hyperinflation begin during either a deflationary depression or deep deflationary recession. (The other 5% is brought about by political stupidity as in Zimbabwe).

Interest rates fall again

The European Central Bank today cut interest rates by 0.75%, its biggest reduction in history. The bigger than expected move comes as euro zone inflation plummets and the euro zone economy sinks deeper into recession. The move takes the ECB's main rate to 2.5%, its lowest in nearly two and a half years, and marks the third cut in barely two months. It is estimated that the latest move, if passed on in full, would knock €128 off the monthly repayments on a 30-year €300,000 mortgage. The ECB has been forced to abandon its gradual monetary policy approach as a wide range of economic indicators in the eurozone are in freefall. The member states of the eurozone are France, Italy, Germany, Belgium, the Irish Republic, the Netherlands, Luxembourg, Spain, Portugal, Slovenia, Malta, Greece, Austria, Finland and Cyprus.

Central banks worldwide are cutting interest rates dramatically to stave off a protracted recession. Earlier, the Bank of England reduced interest rates to 2% from 3%. Sweden's central bank cut its key interest rate by a record 1.75 percentage points to 2% on Thursday and monetary policymakers in Denmark and New Zealand also reduced the cost of borrowing.

Eurozone inflation, meanwhile, plunged to 2.1% in November and is expected to fall dramatically during next year, probably even turning negative (deflation) in some months.

ECB to cut interest rate next week?

A steep fall in eurozone inflation and a rise in the jobless rate has raised hopes that the European Central Bank (ECB) will cut rates sharply next Thursday. Analysts said the ECB could now cut rates by up to one percentage point from their current level of 3.25%.

The downside of the UK interest rate cut!

An interesting but scary observation from David Smith, Economics Editor of The Sunday Times, about the massive interest rate cut in Britain on Thursday:

"There were only two occasions during the 20th century when the level of interest rates was slashed by a third. One was in August 1914, at the start of the Great War, the other was in September 1939, on the outbreak of the Second World War".

David Smith's blog

Interest rates down in the eurozone and the UK

The European Central Bank today lowered its eurozone interest rates by 0.50% to 3.25%. It is the second reduction in less than a month. It is widely expected that the ECB will continue the reductions over coming months in order to bolster weakening economies throughout the eurozone. The rate is expected to be as low as 2% by next spring. Until last month ECB policymakers were reluctant to cut rates due to the effect it might have in raising the rate of inflation as people will have more money which should stimulate demand and increase prices. However, ECB President, Jean-Claude Trichet, said today this was no longer seen as a problem. This is because the rates of inflation throughout Europe are expected to plummet in coming months as our recession takes hold on lowering prices.

Earlier, the Bank of England was much more aggressive in cutting its rate by a whopping 1.5% to 3.0%. The large rate reduction seemed to scare the FTSE as it closed down 5.7%. The reason? The large cut made it clear the Bank of England now thinks the UK is heading for a long recession.

Japan cuts interest rates

Overnight, the Bank of Japan cut interest rates for the first time in seven years. The bank also cut back on Japan's economic outlook, saying strains in global markets are rising and that severe conditions for the world will stay for some time. Rates there are now at 0.3%, down from 0.5%. Japan already had the lowest interest rates in the developed world before the decrease, but despite this many analysts are disappointed the rate was not reduced even more - a fact borne out by the drop in the Nikkei this morning. A soaring Yen along with the slowdown in Europe and the US have put Japanese exporters under severe strain with Sony, Nissan, Toyota and Fujitsu, this week, all reporting miserable profits for the first half of 2008. The Bank of Japan's move followed a rate cut from the U.S. Federal Reserve earlier in the week and will almost certainly precede 0.5% cuts by the European Central Bank and Bank of England next week.

US lowers interest rates but does it matter?

Following the Fed's reduction of US interest rates to 1% yesterday, Time magazine analyses whether lowering rates will have any effect - even a reduction to zero, like what happened in Japan in 1999.

"The U.S. Federal Reserve cut its benchmark interest rate by 50 basis points to 1% on Wednesday, continuing an aggressive effort to fend off a deep recession. The rate now stands at the lowest level since 2004 — and central bankers signaled they may resort to more cuts in the months ahead. The hope is that further rate cuts will stabilize volatile financial markets and accelerate the slowing economy. But as the rate heads toward zero, the Fed is rapidly running out of room for reductions. Not only that, economists and analysts are questioning whether rate cuts produce any bang for the buck under the current extraordinary circumstances.

In a normal cyclical slowdown, lowering interest rates encourages fresh business activity by reducing the cost of borrowing from banks. With more borrowing comes more investment, more jobs and more growth. But these are far from ordinary times. Banks, already burdened with bad consumer and commercial debts, are desperate to clean up their balance sheets and avoid risk — they are not eager to take on more risk by issuing new loans against the backdrop of a deteriorating business climate. American consumers, too, are trying to reduce household debt, so borrowing more money for a new car or to remodel the kitchen is not a high priority. And without greater consumer spending, most companies have little need for new loans to expand operations".

Full article

Americans no longer the big spenders

US consumer confidence plunged to a record low in October as consumers felt the bite of the credit crisis. The US consumer confidence index plummeted to 38.0, its lowest reading since the index was launched in 1967 - down from 61.4 in September, and down from 95.2 twelve months ago! The figure has shocked analysts but is it really that surprising with more than 460,000 a week losing their jobs in America and about 6.1% of the workforce now unemployed? Americans have all but stopped spending on discretionary items (non-essential items) such as cars because they are scared of losing their jobs and anxious about the declining value of their homes. The figures do not bode well for American retailers either as they enter into what is meant to be their busy holiday period.

The news increases expectations that the US Central Bank will reduce interest rates this evening to 1% or maybe even 0.75%. Japan and Britain will then probably follow suit before the end of the week. They hope lower interest rates will boost the economy as people will be more likely to borrow and then increase their spending.