Britain May Cut Rates to Tackle Slump

Economist say the Bank of England will be forced to cut interest rates next week to keep the recession from worsening

The British economy is probably already in recession and there is a growing consensus among economists that the Bank of England will be forced to cut interest rates next week, and possibly before, to prevent the financial crisis triggering a slump. Angel Gurria, the secretary general of the OECD, the international club of developed economies, said yesterday: "We are facing the worst financial crisis since the Great Depression."

Manufacturing, comprising about 17 per cent of gross domestic product, is leading the downturn in the UK. The Chartered Institute of Purchasing and Supply, which regularly polls its members at the "sharp end" of business, yesterday published its lowest-ever reading for business confidence among manufacturing firms. Activity, new orders and hiring intentions are all showing their most depressed ratings since the CIPS survey began in 1992. Not even exporters are doing well, a particularly galling finding given the 15 per cent depreciation in sterling since last year.

Roy Ayliffe, director of professional practice at the CIPS, commented: "Purchasing managers saw levels of output and new work tumble as firms were hit by weakening domestic and foreign demand. In turn, jobs were axed for the fifth month running in an effort to downsize and cut costs."

Analysts were appalled by the CIPS survey. Michael Saunders of Citi European Economics, said: "It now seems highly likely that the MPC [Monetary Policy Committee] will cut rates at the October meeting next week and there is a chance of emergency co-ordinated easing ahead of that meeting if other central banks are also ready to move."

Many economists see a cut next week as more likely than not and even one as large as a half percentage point, with rates falling to closer to 3 per cent this time next year, from their current level of 5 per cent.

In the service sector of the economy, around 70 per cent of the total, the Office for National Statistics confirmed that activity was only flat in the three months to July compared to the three months to April.

Together with the evidence on manufacturing and the dire state of the construction industry, it seems likely that the UK's GDP declined in the third quarter, thereby pushing the economy to the brink of recession. In the second quarter of this year the economy recorded zero growth, and the European Commission and the Organisation for Economic Co-operation and Development are two of the official bodies already saying that the UK will soon see its economy contract.

The Bank of England sees the year ahead as "broadly flat" and admits the possibility of a recession. The IMF issues its influential key forecast next week, and it is likely to tell much the same tale. Indeed, the chances of the global economy sliding into slump are shortening almost by the day, as financial turmoil shreds confidence and turns off the supply of credit to individuals, companies, and the banks.

The CIPS survey comes on the back of a run of other exceptionally weak figures, especially in the housing market, and high-profile announcements on job losses from Ford, ITV News, Lehman Brothers and others. The rapidly darkening outlook has prompted a number of City economists to slash their forecasts for the economy.

The latest to do so is JP Morgan Chase, which put the UK on course for a 1 per cent decline in GDP from peak to trough. The UK economy has not shrunk since 1992. Malcolm Barr, its UK economist, explained: "We are downgrading our forecast to show a deeper and more prolonged period of weakness – something we would characterise as a meaningful recession rather than just one in name."

However, wave after wave of interventions by the world's central banks to ease pressures in the money markets seem to be having some effect. Yesterday, the Bank of England announced a further $30bn of funding and rates in the money markets eased. The situation was also helped by brighter hopes for the success of the Paulson plan, firmer indications that the HBOS-Lloyds TSB deal will go through, and a series of pledges by national governments to guarantee all bank deposits, although Gordon Brown has so far drawn back from an absolute commitment to that.

George Magnus, a UBS economist who spotted the credit crunch before most, spoke for many yesterday when he remarked: "A G7 recession appears all but unavoidable—and a global recession is a distinct possibility in 2009."

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