Bank of England Slashes Key Rate to 3.0% from 4.5%

November 6, 2008

The Bank of of England implemented its biggest rate change by far since the period surrounding the run on sterling in September 1992. No move since February 1993 had exceeded 50 basis points, but officials today cut their Bank Rate by 150 basis points to 3.0%. It seems that William Buiter, a former member of the Monetary Policy Committee at the BOE, was not merely speculating earlier today when he urged officials to slash the rate to 3.0%.

Officials released an immediate statement in which they asserted that “the risks to inflation have shifted decisively to the downside” as a result of sharply lower commodity prices, the “most serious disruption for almost a century” in the global banking system, sharply tighter money and credit conditions, substantial declines in equity prices, and prospects for a “severe contraction” of output to continue in the near term. No component of private demand — consumption, business investment, housing, and exports — has been spared. Inflation risks have swung to the downside in spite of sterling depreciation, and officials are now warning of a “substantial risk of undershooting the inflation target.” New inflation and growth forecasts will be published November 12th, and minutes from today’s meeting, which I expect to show unanimous support for today’s action, are due November 19th. The statement implies that rate cutting is not over, asserting that prevailing market rates “contain a substantial risk of undershooting the inflation target.” It is not unreasonable to presume that the bank rate eventually will drop as far as the current fed funds target of 1.0%.

Historical footnote: Today’s drama still falls short of Black Wednesday (September 16, 1992) when the Bank of England in two steps first hiked the bank rate from 10% to 12% and then to 15% to defend sterling, only to give up and cut the rate back to 12%. On Sept 17th, the rate was lowered another 200 basis points back to 10%, followed by 100-bp further reductions to 9% on Sept 22, 8% on October 16, 7% on November 12th, and 6% on January 26, 1993, which was the last time that officials did a move of more than 50 basis points before today.

The size of the cut by the Bank of England raises the possibility of a bigger-than-50-bp cut by the ECB today, but a 50-bp rate cut at the same time by the Swiss National Bank suggests that the ECB will not come close to matching the size of the Bank of England’s move.

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