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November 07, 2008

Bank of England Takes Bold Step to Ward Off Severe Recession
by Victoria Marklew

The Bank of England's Monetary Policy Committee (MPC) acted decisively this morning, cutting the Bank Rate 150bps to 3.00% - its lowest level in over fifty years and the largest rate cut since the Bank gained full policy independence in 1997.

Chart 1

The MPC statement noted the "very marked deterioration in the outlook for economic activity at home and abroad" and the fact that the risks to inflation "have shifted decisively to the downside," leading to a "substantial risk" that headline CPI would undershoot the 2.0% target in the medium-term. The Committee pulled no punches, describing the sharp fall in output in the UK in the third quarter, the recent tightening in money and credit conditions as a result of the serious disruption in the global banking system, and business surveys and reports that point to "continued severe contraction in the near term."

The economic data have certainly been unremittingly gloomy in recent weeks. Today came the Halifax house price report for October, which revealed that prices fell 2.2% on the month (the ninth successive decline) and 14.9% on the year - the steepest fall since the series began in 1983. Halifax calculates that prices have now fallen 15.7% from their peak, which means that many thousands of homeowners probably are already in negative equity (where the mortgage exceeds the value of their home).

The financial services sector has played a key role in underpinning the UK's strong and steady economic growth in recent years. Reading between the lines, the MPC is concerned that the financial sector's woes, combined with a global demand slump, risk pushing the UK into a severe recession. We doubt that today's rate cut is the last. There may be an indication of the Committee's policy outlook in the minutes of today's meeting, which will be released November 19. The BoE's Inflation Report, to be published November 12, will include the Bank's latest forecasts for output and inflation.

ECB Cuts Again But Accelerating Slowdown Points to Further Easing in December

As expected, the European Central Bank (ECB) lowered its refi rate again today, taking it down 50bps to 3.25%. In his subsequent press conference, Governor Trichet stated that the Council discussed cutting by 75bps but was unanimous in its decision to lower by 50bps. Unlike in the UK (see above), the minutes of this discussion will never be released, but it appears that the Governing Council missed a chance to move more aggressively.

Chart 2

Earlier this week the European Commission released its latest economic forecasts, anticipating real GDP growth of just 0.1% for the 15-member Euro-zone next year, and 0.2% for the 27-member EU. Q3 GDP data are due November 14, but the Commission stated that the Euro-zone is already in a technical recession. Assuming that the Q3 data are as weak as expected, and given the extent to which forward-looking data are deteriorating, the ECB is likely to ease again at the December 4 policy meeting.

One indication of the severity of the looming downturn across the Euro-zone is the state of German manufacturing orders. Today came the news that September's orders posted their biggest monthly fall since 1990, plunging a seasonally-adjusted 8.0% on the month, led by an 11.4% drop in foreign orders.

Chart 3

Swiss National Bank Opts For Intra-meeting Rate Cut

The Swiss National Bank (SNB) announced an intra-meeting rate cut today, lowering its target band for three-month Swiss franc LIBOR to 1.50-2.50%, down from 2.00-3.00% previously, and aiming for the mid-point - effectively, a 50bps rate cut to 2.00%.

Chart 4

Although Swiss inflation eased by less than expected in October - the headline rate came in at an annual 2.6%, down from 2.9% in September - there are plenty of other signs for a more marked decline in inflation and that the economy is headed for recession going into 2009. The SNB stated today that the global economic outlook "has deteriorated more severely than anticipated" and warned that in Switzerland "growth in 2009 might even be negative."

Earlier this week the SVME Purchasing Managers' Index showed that Swiss manufacturing contracted for the second consecutive month in October. The PMI fell to 47.0, down from 47.8 in September and its lowest since mid-2003. The last time the PMI remained below 50.0 for two consecutive months was back in the summer of 2003, when the economy was struggling out of a prolonged period of weak-to-negative growth. That was also the last year the Swiss economy posted a full-year contraction.

Last week the KOF Economic Institute released its latest leading indicator, which points to the economy's likely performance in six months' time. The October indicator dropped to 0.35 from 0.52 in September, its lowest level since July 2003.

Chart 5

With Switzerland's major export markets slowing sharply the economy is set to fall into recession around the turn of the year, and could be in for more than two consecutive quarters of negative real GDP growth. If current trends continue, the SNB is likely to ease again at its next scheduled policy meeting on December 11.

Victoria Marklew
The Northern Trust Company
Economic Research Department
"The economics of what is, rather than what you might like it to be."
50 South LaSalle Street, Chicago, Illinois 60675

The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The Northern Trust Company does not warrant the accuracy or completeness of information contained herein, such information is subject to change and is not intended to influence your investment decisions.

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