Would cutting interest rates really help the UK economy deal with a coronavirus pandemic?

It might satisfy financial traders in the City of London but would it help, say, market traders on high streets around Britain? Ben Chu looks into the question

(Reuters)

America’s Federal Reserve has gone big in response to the coronavirus outbreak. A half percentage point cut in the Fed’s interest rate is the largest single reduction in the cost of borrowing implemented by the US central bank since those frantic days some 12 years ago when it seemed like the financial world might be about to end.

Now eyes turn to the Old Lady of Threadneedle Street for her turn to show and tell. Financial markets are now pricing in a cut in interest rates from the Bank of England’s interest rate from their current level of 0.75 per cent.

And many expect the reduction to come well before the next scheduled meeting of the Bank’s rate-setting Monetary Policy Committee on 26 March, possibly even before Mark Carney leaves as Governor and hands over to Andrew Bailey on 16 March.

If the Bank doesn’t go big like the Fed expect markets to react badly. Although judging from their reaction to the Fed’s cut don’t expect them to show much enthusiasm either if rates do go down.

Yet amid the speculation about markets it’s important to ask the question: would a reduction in the national cost of borrowing actually help the UK economy to cope in the face of this potential disease pandemic?

It might satisfy financial traders in the City of London but would it help, say, market traders on high streets around Britain?

Views diverge on this question among economists.

But to get to an answer it worth considering broad economic mechanisms.

First, there’s what’s known as economic “supply”, the capacity of the economy to produce goods and services.

The coronavirus is primarily a supply shock to the world economy. Companies, particularly manufacturers in China, have been unable to fulfil their order books because of the shutdown of large swathes of industry in that country in an attempt to contain the virus.

And this threatens a knock-on impact on the many Western companies which have Chinese firms in their supply chains.

This is not a problem of credit being too expensive. Rate cuts won’t fix a broken supply chain, as the Chair of the Federal Reserve, Jay Powell, admitted this week.

But when it comes to the economic impact of the coronavirus, it’s also important to consider “demand”, or total spending in the economy by households and companies.

Think about the many ways the coronavirus outbreak is already undermining demand: reducing tourism into the UK from China, forcing the cancellation of various conferences and events, deterring people from going to restaurants. That’s a lot of spending sucked out of the economy. And it’s very easy to see it getting worse.

Could an interest rate cut help here? Unlike with supply, it is possible cheaper borrowing will spur companies and some individuals to spend more money, even in the face of rising fears about coronavirus.

It wouldn’t be a panacea, but it’s arguably worth trying.

Yet no one should be delude themselves that policymakers at the Bank can pull various monetary levers and make this problem go away.

Much more important in helping the UK economy to weather this coronavirus shock will be measures to help financially stressed companies directly, perhaps by giving them extra time to make their bank loan or tax payments.

Many firms will be – or could soon be – suffering from short-term customer demand problems which, unless they get some relief, could result in them going out of businesses or shedding workers. Thus would an economic demand problem become an economic supply problem.

Even measures to prevent this financial distress though, can only do so much good in the face of a potential shock to the economy from a pandemic which craters consumer confidence.

It was said during the years following the financial crisis that central banks were the “only game in town” in terms of stabilising the economy.

Today that’s a rather fitting description of our virus-fighting medical authorities.