Hefty rate cut sends pound plummeting

So now we know. It’s not bad; it’s worse than that. The full one percentage point cut in interest rates takes them down to just 2%, matching the lowest level ever in the Bank of England’s 314-year history. Only nine months ago, the base rate was 5.75%. The Bank does not make such drastic and deep cuts without being very worried indeed about the economy.

There is no point in waiting for the official figures next month to confirm that Britain is in recession. Only this week indicators from manufacturing, construction and services revealed further steep declines in confidence and output. And the government’s promise that it will help with their mortgages people who lose their jobs or suffer significant falls in income due to working short-time underlines just how bleak the prospects for 2009 are looking. We already know that the economy will shrink – some think by about 1% – and one of the City’s most closely watched (and complex) indices implies that a record number of companies are on the verge of default.

The problem with the second hefty rate cut is that nobody can be certain what signal it sends to the consumer. November’s cut from 4.5% to 3% did little or nothing to stimulate spending – witness the massive pre-Christmas sales – so why should a second massive dose be any different? Remember, there are five savers for every borrower, and while many banks may not pass on the full rate cuts in their mortgage rates, they are certain to slash what savers receive. 

For the drinks sector, the picture gets ever more painful. While big retailers demand deep discounts so they can continue to attract shoppers with offers, the suppliers are caught in a double bind. Volumes are falling and costs are rising. The immediate reaction in the money markets to the second big rate cut was to send the pound plummeting to $1.45 and €1.15, its lowest ever against the single currency. Such is Britain’s plight and so enormous the amount the government needs to borrow that nobody wants the currency.

Effectively, sterling has been devalued by more than 20% this year against the euro. So who will take the pain? Not the supermarkets. Both producers in Europe and their UK agents are going to have to accept even lower margins or sales will disappear, possibly forever as cash-strapped customers trade down. The only hope is that the latest rate cut saves some companies that otherwise were doomed to failure. But come January and February some big names are bound to go under.

Finance on Friday, 05.12.08