Unemployment fears increase pressure on Bank for rate cut

Downturn expected to be worse than the early 1990s
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The Independent Online

Pressure on the Bank of England for another radical cut in interest rates mounted yesterday, as the latest surveys of business confidence in the services sector signalled a further steep rise in unemployment. At 2 per cent, Bank rate is already at a 57-year low, and is almost certain to be trimmed, leaving the cost of borrowing at its lowest since the Bank was founded in 1694.

The Chartered Institute of Purchasing and Supply/Markit survey for December revealed that many employers are resorting to redundancies to reduce payroll costs. The news came on the same day that the Nationwide Building Society reported a 2.5 per cent fall in house prices during last month, bringing the annual rate of decline to 15.9 per cent. The latest Business Trends report from the accountancy firm BDO Stoy Hayward reveals that businesses expect the downturn will be worse than the early 1990s. A range of high-profile administrations, including Woolworths and Waterford Wedgwood, completes the picture of an economy in dire need of an interest rate cut from the Bank when it announces its decision at noon tomorrow.

Overall, December's seasonally adjusted CIPS/Markit Business Activity Index for the service sector, representing some 70 per cent of the economy, remained well inside negative territory. Any reading below 50 indicates a contraction, and, at 40.2, it is broadly unchanged on November's series low of 40.1, feeding some hopes that sentiment may be bottoming out. A fall in input costs also offers a glimmer of hope. However, 2008 was still the worst calendar year since the survey began in mid-1996. The employment sub-index dropped to a record low of 40.5 from 43.1.

Paul Smith, senior economist at Markit Economics, said: "The VAT reduction aside, firms are now resorting to discounting strategies as part of efforts to drum up new work, but with little success so far, while expectations for future activity remain exceptionally low. This has all combined to put companies firmly in recessionary mode, cutting jobs at a rate unprecedented in twelve-and-a-half years of data collection."

Economists agree that the outlook is poor. Alan Clarke, UK economist at BNP Paribas, commented: "The typical relationship between the CIPS surveys and growth reinforces our view that the fourth quarter of 2008 will see a contraction in excess of 1 per cent, quarter to quarter. The relationship with Bank rate also reinforces our forecast for a 1 percentage point rate cut."

If the official data does indeed show a 1 per cent or greater fall in GDP during the last three months of last year when the figures are published in a few weeks, then that will indicate that the economy is heading for a recession much more severe than ministers have so far admitted to. The most pessimistic forecasts now put the contraction this year at close to 3 per cent – the worst since the end of the Second World War. That would also mean even higher public borrowing and more bad debts and losses for the banks.

Even if the Bank does cut interest rates to close to zero over the next two months, few believe that this will be the end of official activity to stimulate the economy and ease the credit crisis. A national loan guarantee scheme, a further recapitalisation of the banks and the purchase of banks' "toxic debts" are all options being discussed.

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