February 2009 – UK policy rates cut to historic low of 1%

The Bank of England’s Monetary Policy Committee (MPC) has lowered the Bank Rate by 50bps to 1.00%.

The UK is in recession – indeed the cumulative output in the last two quarters has been 2.1% – close to the 2.6% peak-to-trough decline recorded in the last recession in the early 1990s. There is much further to go in the downswing.

Despite the sharp fall in sterling and cheaper borrowing costs, corporate Britain is contracting at a rapid rate. Exports might have been expected to absorb some of the spare capacity – but depressed overseas demand is a big obstacle to stage an export-led recovery.

Consumers have become net borrowers over the last ten years and a rebalancing of the economy is needed in favour of a higher level of household saving. The savings ratio will probably have to climb to 5 per cent of disposable income or higher in order to pay off existing debts and rebuild household balance sheets. But saving is more difficult during a recession and when the average returns on deposit accounts are so low. For the time being, the Bank of England has signaled that irate savers are playing second fiddle to the need to prevent a calamitous collapse in output and jobs.

Economists at the Royal Bank of Scotland estimated that a sudden increase in saving could bring about the worst ever recession in modern UK history.

“To take their savings ratio back up to target, households will have to shift from net borrowing to the tune of £30bn in 2008 to net saving of some £45bn – a swing of £75bn. If this adjustment were to happen abruptly (this year only), it would shave roughly 5 percentage points off GDP growth.”

A student chart-based handout covering this interest rate decision is available by clicking on the download link below:

Download student worksheet