Tight Credit Stirs Central Banks - WSJ.com

Tight Credit Stirs Central Banks - WSJ.com

Tight Credit Stirs Central Banks

U.K. Rate Cut Is First
In More Than Two Years;
ECB Girds for Slowdown

By JOELLEN PERRY and ALISTAIR MACDONALD
December 7, 2007; Page A2

LONDON -- Mounting concerns about the economic fallout from the global credit-market turmoil trumped inflation worries in Europe as the Bank of England cut its key rate for the first time in more than two years, while European Central Bank policy makers held steady despite persistent price pressures.

The Bank of England lowered its key policy rate by a quarter-point to 5.5%, its first cut since August 2005. The ECB, meanwhile, kept its key rate at 4% despite rising inflation, as policy makers acknowledged that growth in the 13 countries that share the euro currency will slow next year.

• The News: The Bank of England cut its key rate for the first time in over two years, while the European Central Bank held rates steady.

• The Background: Investors in the U.K. have been clamoring for a cut amid growing signs the economy has taken a turn for the worse.

• What's Next: Many analysts see the ECB on hold throughout 2008, though a minority still predict a cut in the first half.

The moves come at a particularly sensitive time for the United Kingdom, where investors and executives have been clamoring for a rate cut amid growing signs that the economy has taken a turn for the worse. As recently as August, many analysts expected robust house-price and financial-sector growth, among other things, to bring U.K. rates higher by year end. But as credit turmoil has hit mortgage lenders such as Northern Rock PLC and driven up consumer interest rates, the latest data have shown the service sector slowing sharply and house prices falling at the fastest rate in 15 years.

"It's official: They're sufficiently confident [the credit crunch] will affect the economy," said Ross Walker, U.K. economist with the Royal Bank of Scotland, which recently lowered its forecast for 2008 economic growth to 2% from 2.3%. Futures markets see the U.K. central bank cutting rates by as much as a full percentage point more by the end of 2008.

In a statement that accompanied the interest-rate move, the Bank of England's nine-member Monetary Policy Committee said "conditions in financial markets have deteriorated and a tightening in the supply of credit to households and businesses is in train, posing downside risks to the outlook for both output and inflation further ahead."

Investors, who had largely anticipated the move, reacted coolly. The FTSE 100 index ended down 8.2 points at 6485.60, though analysts projected the prospect of future cuts would buoy markets going forward. The pound was at $2.0265 in New York trading, compared with $2.0252 Wednesday.

In contrast to the situation in the U.K., cautious optimism from ECB President Jean-Claude Trichet dispelled some market expectations that interest rates in the 13 countries that share the euro will fall soon. Even as he unveiled forecasts predicting 2008 growth around 2%, down from September's 2.3% forecast, Mr. Trichet said "the economic fundamentals of the euro area remain sound," though he stressed the continuing market turmoil added uncertainty. His comments highlighted policy makers' belief that a "resilient" global economy will support euro-zone exports next year, while strong corporate profits and falling unemployment boost consumption.

Indeed, amid fears that a short-term inflation increase spurred by soaring food and energy prices could seep into wage demands and push up other prices, Mr. Trichet said "some" of the bank's 19 Governing Council members had supported an interest-rate increase. Euro-zone inflation hit a 6½-year high of 3% last month, and ECB staff yesterday forecast the rate will hover around 2.5% next year, markedly above the 2% forecast in September and the ECB's preferred range of just below 2%. But a predicted fallback to 1.8% in 2009 could keep policy makers on hold.

Markets and many analysts see the central bank on hold throughout 2008, though a minority still predict a cut in the first half. Expectations of better returns on the euro led investors to buy the currency, pushing its value up against the dollar. Yesterday, the euro was at $1.4627, up from $1.4611 Wednesday.

Mr. Trichet's relative optimism was shared by the Organization for Economic Cooperation and Development, which said yesterday the U.S. will avoid recession and predicted cooling housing markets and tightening credit conditions will extract only a moderate toll on global growth. Combined economic growth among the members of the Paris-based club of wealthy nations will slow to 2.3% next year, down from the 2.7% forecast made in May, the OECD said in a twice-yearly report.

While renewed market turmoil or further commodity-price rises could damp growth further, the scenario "is actually not that bad in view of recent shocks," said Jörgen Elmeskov, acting head of the OECD's economics department.

Still, central banks across the globe are adjusting interest-rate strategies as fears mount that the fallout from the credit-market turmoil could be severe. The Bank of England's downward move came two days after the Bank of Canada cut rates for the first time since April 2004, lowering by a quarter-point to 4.25%, and coincided with a surprise move by Indonesia's central bank to lower rates by a quarter-point to 8%.

The Fed, which already has cut its key rate by 0.75 percentage point since September, is widely expected to cut rates again on Tuesday by at least a quarter-point. Fed officials are also discussing other ways to respond to the global reluctance of banks to lend to one another for more than a few days.

--Paul Hannon and Ilona Billington contributed to this article.

Write to Joellen Perry at joellen.perry@wsj.com and Alistair MacDonald at alistair.macdonald@wsj.com