Britain: An Ounce of Prevention against Global Risk

The Bank of England decided to take out some insurance for the British economy, which is becoming increasingly vulnerable to outside shocks.

The BOE caught financial markets off guard on Feb. 6 when it cut its policy rate by a quarter-point to 3.75%, the lowest since 1955. In announcing the move, the BOE said both domestic and global demand prospects for the next two years "are somewhat weaker than previously anticipated."

In its Feb. 12 quarterly report, the BOE trimmed its forecast for 2003 economic growth to 2.5%, down from the 3.1% expected in November. And it repeated its belief that any runup in inflation was temporary and would "wind down" by the end of 2003. The report heightened expectations that the bank will cut rates again, perhaps as early as spring.

But the prospects of lower borrowing costs are increasing fears of a housing bubble. Home prices have been running at double-digit increases for almost two years, and consumers, using cash from mortgage refinancings, have been the main engine for the British economy, which grew by an estimated 1.8% in 2002. Consumers kept their spree going in January when same-store sales grew by the fastest rate in five months.

Further stimulus would clearly help the sagging manufacturing sector. Industrial output in 2002 shrunk by 3.5% last year, the biggest decline since 1991. Lower rates should help the factory sector by spurring domestic capital spending and by weakening the pound. A cheaper currency would lift export growth. Sterling has fallen about 2% since early December on a trade-weighted basis.

The BOE's rate-cut statement avoided any mention of geopolitical risks in the economic outlook, but that has to be on policymakers' minds. Britain remains the U.S.'s closest ally in its confrontation with Iraq, so any escalation is apt to affect Britain far more than other nations in Europe. As a result, the BOE's move and any more cuts could be viewed as a way to insulate the British economy from global uncertainties.

By James C. Cooper & Kathleen Madigan

    Before it's here, it's on the Bloomberg Terminal.
    LEARN MORE