U.K. Slashes Interest Rate; Europe Cuts Too

The Bank of England cut its key lending rate to 3% from 4.5%, signalling deep concern as the U.K. economy struggles with falling house prices and sharply tighter credit conditions. The European Central Bank, which makes monetary policy for the 15 countries that share the euro currency, cut its key rate by a half percentage-point to 3.25%, as expected. Switzerland's central bank joined in, cutting its key rate target by a half percentage point to 2% in an unusual between-meeting move.

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Thursday's cuts followed a round of emergency cuts less than a month ago, when the same European central banks cut their key rates by a half percentage-point, in tandem with the U.S. Federal Reserve and two other central banks.

The scale of the Bank of England cut caught most analysts by surprise. Debate in the U.K. had been whether the bank would cut by as much as three quarters of a percentage point, with the most bearish on the U.K economy demanding, but not always expecting, a full percentage point cut.

The central bank's nine-member Monetary Policy Committee has never cut its key rate by more than a half percentage point since it gained independence from the U.K. government in 1997. The last time the bank cut by a full percentage point was 1993, when the U.K. was mired in recession. The central bank's key rate was last as low as 3.0% in 1954

"It's a spectacular move and it confirms that the [central bank] has finally woken up to the seriousness of the situation facing the U.K. economy," said Jonathan Loynes, chief U.K. economist at Capital Economics in London. "But there's much more work to do. Even at 3%, U.K. rates are still well above those in the U.S. when the economic outlook here is arguably even worse than in the U.S."

The Fed's current interest-rate target is 1%. Loynes expects U.K. interest rates to fall to at least 1% in coming months. Economists at Global Insight expect the U.K. central bank to reduce interest rates by a further 50 basis points to 2.50% in December and sees rates at 1.50% by mid-2009. Economists also expect the ECB to deliver further hefty cuts, perhaps as soon as next month.

A raft of miserable economic data on Thursday underscored the severity of the slowdown facing western Europe. Spanish industrial output fell 8.8% in September compared to a year earlier, the fifth consecutive monthly fall marking the longest period of decline since 2001, according to Spain's National Statistics Institute.

Weaker foreign demand and a falloff in capital goods orders pushed manufacturing orders in Germany, Europe's largest economy, down at their strongest pace since records began in 1991. Orders tumbled by 8% in September compared to August, far worse than the 2.6% drop expected by economists polled by Dow Jones Newswires.

"Weakness is particularly coming through .. foreign capital goods orders, particularly from the euro area, which had of course been the major underpinning of German economic expansion," Barclays Capital economist Julian Callow wrote in a note to clients. "Overall, it goes to show that the euro area is witnessing the worst economic collapse since the 1992-93 recession," Callow wrote, though he noted calendar adjustments and one-off events likely exacerbated the drop in orders for manufactured goods.

Interest rates on euro-zone household and corporate loans also rose in September, underscoring fears the bloc will soon experience a full-fledged credit crunch. Average interest rates on new floating-rate mortgages, which account for nearly half of new mortgage borrowing across the bloc, rose to 5.8% from 5.77%, according to the ECB.

The European Commission said Monday that the $12.2 trillion euro-zone economy is likely already in a technical recession and forecast growth would slump to 0.1% next year. That would be the worst showing since 1992, when output in the countries that now share the currency shrank by 0.7%.

The U.K.'s biggest mortgage lender said house prices fell by a record 14.9% in October compared to last year. The slide, which brought house prices down 15.7% from their peak, was the biggest since records began in 1983. U.K. house prices are falling at a much faster pace than during the U.K.'s last major housing and economic downturn in the early 1990s. The U.K.'s economy shrank by 0.5% in the third quarter, more than had been expected, while economic data since has only confirmed economists and politicians fears that the U.K. is already in recession.

In a statement, U.K. policy makers explained their surprise move by noting rapidly deteriorating growth prospects raise the spectre of sharply falling prices. The Bank of England targets an annual inflation rate of 2%. Commodity prices pushed U.K. inflation to 5.2% in September, but in a statement accompanying its decision, the central bank said falling commodity prices and a sharp economic slowdown means there is "a substantial risk of undershooting the inflation target."

In a further sign of falling demand in the U.K. and across Europe, new car registrations fell in October in all five major European car markets. New registrations were down 23% for the month in the U.K., 7.3% in France, 40% in Spain, 19% in Italy and 8% in Germany, according to industry figures.

Switzerland's central bank raised the specter of recession as well, saying in a statement explaining its cut that "the global economic outlook has deteriorated more severely than anticipated, which will impact growth in Switzerland in the next few quarters; growth in 2009 might even be negative."

-- Joellen Perry and Alistair MacDonald, The Wall Street Journal