Could the authorities be running out of options to avert the worst economic downturn since the Second World War? Even as the Bank of England was cutting rates yesterday to historic lows – by 1 percentage point to 2 per cent, the lowest since 1951 – the Chancellor was hinting that still more desperate measures may be required to restore the financial system to health: “We now need to go further, to ensure banks can resume lending to businesses, which is absolutely critical … I think there are a number of things we can do, we are discussing them with the banks, and we will be able to say something shortly.”
With growing evidence that interest rate cuts and the reduction in VAT may not have the desired effect, Mr Darling admitted that there may have to be a “third leg” to policy – to restore bank lending to people and businesses. The European Central Bank followed the Bank of England by cutting 0.75 points off its base rate, down to 2.5 per cent.
The dire state of the economy was highlighted again yesterday, when the Halifax revealed a 2.6 per cent fall in house prices in November alone, bringing the annual rate of decline to 16 per cent; many economists believe prices will fall by a further 20 per cent. A 45 per cent slide in private car sales also shocked analysts – a clear signal of a collapse in consumer confidence and the emergence of a deflationary mindset. Thousands of job losses were announced this week, with unemployment tipped to reach three million by Christmas. Woolworths rather than Lehman Brothers has become the most visible symbol of the crisis, as it has moved from the City to the high street. This explains the urgency of recent moves by the Treasury and the Bank of England.
Mr Darling’s thinly veiled threat came as the Bank of England cut interest rates to a level matching anything seen since the Bank was granted its charter to bring order to the nation’s finances in 1694.
And yet ministers and the Bank itself recognise that this can only be a part of the resistance to a slump, because the banks and building societies have proved so resistant to passing the cuts in official rates on to their customers.
Last night Mr Darling conceded that cuts in bank rates and measures such as his own reduction in VAT are less important than freeing up the credit markets: “I believe a combination of these two measures – pre-Budget report and the interest rate decisions – are necessary.”
Mr Darling said he had met the banks again, and “I said two things. Firstly, we are ready to do whatever we can to help the banks not only build their position but also to lend. But it is absolutely essential that they help their customers and that they treat their customers fairly.I also said I wanted to see the interest rate reductions announced by the Bank of England passed on.” It was clear last night that the country’s leading lenders – including some of those where the Government is about to take a significant shareholding – are defying ministers’ demands. The Halifax and the Nationwide made clear that they would only pass on part of the Bank’s 1 per cent reduction. Last week the Governor of the Bank of England, Mervyn King, said that getting the banks to lend again was “the most important thing”. Like Mr Darling, he hinted at “direct measures”, and refused to rule out full nationalisation.
The Bank’s decision demonstrates the immediate dangers to the economy. A string of exceptionally poor economic indicators seems to confirm anecdotal and survey evidence that the economy may have “fallen off a cliff” in recent weeks. In a statement accompanying its decision the Bank’s Monetary Policy Committee said: “The downturn has gathered pace. Consumer spending and business investment have stalled, while residential investment has continued to fall. Despite the actions taken to raise bank capital, ease funding and improve liquidity, conditions in money and credit markets remain extremely difficult. The Committee noted that it was unlikely that a normal volume of lending would be restored without further measures.”
The pound’s weakness may also restrict the Bank of England’s ability to act – it hit an all-time low against the euro and a seven-year low against the dollar yesterday.
As interest rates approach zero observers are increasingly talking about the Government “printing money” to spend its way out of the recession – leaving the budget deficit “unfunded” – or “quantitative easing”, in economists’ jargon. The Treasury is already believed to have modelled how this might revive the economy. The chairman of the Treasury Select Committee, John McFall, said that “the situation we’re in globally is so dire that we need to have extraordinary measures on the agenda”.
Meanwhile, Gordon Brown will host a crisis summit with other European leaders to discuss plans to boost the EU’s ailing economy with a vast spending package. The Prime Minister will meet the French President Nicolas Sarkozy and the European Commission president Jose Manuel Barroso in London on Monday. No invitation has gone to Germany’s Chancellor Angela
Merkel, who is sceptical about Mr Brown’s fiscal stimulus plans.
The summit is taking place three days before the EU Council in Brussels, where leaders are due to consider the next moves in their response to the downturn.
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