CREDIT CRUNCH

Oil prices down – you read it here first!
House prices down.
Commercial property prices down.
Mortgages down.
New borrowing for everyone down.
People’s spending squeezed.

How can the Bank think this is the background to higher inflation in a year or so?

Overall price increases are still a bit above target – that’s because the Bank and the MPC got it wrong a couple of years ago, keeping interest rates too low for too long. It is also because the government owned or influenced monopolies like railway fares, Council tax and fuel tax have gone up.

Yesterday sterling fell and the UK Stock market rose sharply. Markets are clearly expecting an interest rate cut today.

Whether the Bank does or does not cut rates, expectations of more cuts will build up in the days ahead, as no-one in the markets thinks the Bank can remain unconcerned about what is going on in the banking sector for much longer. Today’s problems for the banks are tomorrow’s problems for everyone else, as money makes the economy go round and banks supply the money.

This entry was posted in Blog. Bookmark the permalink. Both comments and trackbacks are currently closed.

4 Comments

  1. apl
    Posted December 6, 2007 at 9:06 am | Permalink

    JR:

  2. Alice
    Posted December 6, 2007 at 5:43 pm | Permalink

    I fear that this interest rate cut might actually work. It might encourage people to spend over Christmas, and in the short run stabilise house prices. Who knows? In a wave of misplaced euphoria, house prices might take off again and record another year of double-digit growth. Perhaps in the spring, the Bank of England might supplement this interest-rate cut with another one. Maybe by late summer, interest rates will be down to 4%.

    However, lurking in the background, is personal sector indebtedness. If the Bank of England interest-rate cut proves to be successful, debt ratios will rise further. Sooner or later, the private sector has to stop consuming and begin to repair its balance sheets. My fear is that private sector indebtedness will deteriorate further in the next year, and when the day of reckoning finally arrives, the UK will face a calamitous banking crisis. This crisis will come about because of rising personal sector defaults.

    If the Bank of England had held rates steady today, consumption would slow down, and with it economic growth would decelerate. In the worst-case scenario, the UK might have entered a recession during the first half of next year. However, personal sector debt levels would begin to fall, banks would begin to reduce their exposure, and eventually the situation will improve. Times would have been difficult, to be sure, but delaying the process of adjustment will only make matters worse.

    In summary, today's decision to cut rates is a disaster. It was cowardly, self-interested, and ultimately it will bring more problems than it will solve. A shameful day for the Bank of England.

    Alice

    reply: I don't agree. It was a necssary but late and small move in the right direction. the credit crunch is too severe a way of adjusting balance sheets.
    UK Housing Bubble .

  3. APL
    Posted December 7, 2007 at 12:42 pm | Permalink

    JR: "I don't agree. It was a necssary but late and small move in the right direction. the credit crunch is too severe a way of adjusting balance sheets."

    So if I understand the situation. You agree that it is a matter of concern that individual indebtedness is at all time high levels.

    You agree that low interest rates over the last ten plus years have contributed to this level of debt.

    You even say that interest rates were kept 'too low for too long'.

    You have even in the past described the state of the housing market as a 'bubble', implying the price for an asset does not reflect a realistic value of that asset.

    Yet your solution to the problem is more artificially low interest rates? This solution would encourage all the problems you highlight.

    Nor would it encourage more people to save rather than spend – thus easeing (over the longer term) the credit crunch.

    It seems to me you have no faith in the market, what distinguishes you from Alistair Darling?

    How about abolishing the MPC and allow individual banks to set their own rates according to prevaling market conditions?

    Reply: It is a matter of timescales. For several years the MPC/Gordon Brown took risks with inflation by keeping rates too low for the then conditions, allowing heavy indebtedness and inflation to increase. The banks had plenty of money and the Basel rules allowed them to lend off balance sheet in liquid debt markets.
    Today all that has changed. Markets are short of cash. Banks cannot lend on the same scale. Cutting interest rates is not designed to lead to a further borrowing surge, but to relax the obvious tension in the system brought on by illiquidity in the debt markets.
    You do need a Central Bank which acts as banker of last resort to the clearing banks, and which sets a rate for such lending.

  4. APL
    Posted December 7, 2007 at 6:07 pm | Permalink

    JR: "It is a matter of timescales. For several years the MPC/Gordon Brown took risks with inflation by keeping rates too low for the then conditions, .."

    By the way, this was the sort of thing that Kenneth Clarke was happy to do, only his rationale was that, because the European central bank had low interest rates, we should too.

    JR: "You do need a Central Bank which acts as banker of last resort to the clearing banks, and which sets a rate for such lending."

    Why?

    Do you have any faith in for example, the Zimbabweian central bank?

  • About John Redwood


    John Redwood won a free place at Kent College, Canterbury, and graduated from Magdalen College Oxford. He is a Distinguished fellow of All Souls, Oxford. A businessman by background, he has set up an investment management business, was both executive and non executive chairman of a quoted industrial PLC, and chaired a manufacturing company with factories in Birmingham, Chicago, India and China. He is the MP for Wokingham, first elected in 1987.

  • John’s Books

  • Email Alerts

    You can sign up to receive John's blog posts by e-mail by entering your e-mail address in the box below.

    Enter your email address:

    Delivered by FeedBurner

    The e-mail service is powered by Google's FeedBurner service. Your information is not shared.

  • Map of Visitors

    Locations of visitors to this page