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Are zero interest rates key?

November 6th signalled a landmark move by the UK, which has widely been seen as the mover and shaker in the credit crisis, not least because it has one of the worst performing economies. This was when the Bank of England slashed interest rates to three per cent from 4.5 per cent - the biggest reduction since 1981, taking rates to the lowest level since 1955. The Bank's nine-member committee had considered a bigger one and was aiming to take another look at rates after the Chancellor's pre-Budget report on November 24th.

All forecasts are down among industry analysts, with Threadneedle predicting 2009 contractions in the UK, Japan and the US, where interest rates were cut to one per cent from 1.5 per cent by the Federal Reserve at the end of October (and reduced from two per cent at the start of October as an emergency measure). Japan ended six years of zero interest rates in mid-2006. On Halloween the Bank of Japan cut its key rate to 0.3 per cent from 0.5 per cent. It is set to be the first time in 30 years that major economies go into recession simultaneously, JP Morgan commented.

But what is wrong with zero interest rates, JP Morgan’s David Shairp asks - and not for the first time. Dramatic reductions might be needed in a crisis in a "shoot now ask questions later" over a "conserving ammo" philosophy. As reports suggested in last month's round up - the right decisions need to be made and fast. Like Threadneedle, JP Morgan saw forecasts continue to be downgraded across all 21 markets it covers. Emerging economies are suffering now with gross domestic product (GDP) projected to half next year in Brazil on energy lulls. While China is pre-empting problems to lessen seemingly unavoidable blows.

Perhaps a zero interest rate policy would free up spending. In the US and UK in particular, retail sales are down, pointing to a quieter Christmas. UK department store chain John Lewis reported 13 per cent drop in the second week of November compared with the same period last year. The energy and mining sectors were also bad. Threadneedle foresaw slowdowns in capital projects and spending on IT hardware with telecoms also affected. Intel surprised investors by issuing a profit warning, Barings Global Weekly Review said. A high dollar and yen also show gifts are unlikely to come from the US or Japan in other countries this year, as exports head down.

Christmas certainly looks put off until 2016 for taxpayers in the UK - that's the time it has been forecast to take until the government only borrows for investment. More financial stimulus spells more money from somewhere and borrowing has reached record levels this year. The UK is expected to ring in the New Year an estimated £78 billion in debt up from £43 billon the Chancellor originally predicted in March 2008.
Although people have not seen tax rises now, they will come to haunt the public later with a 0.5 per cent increase in National Insurance payments outlined in the pre-Budget report and a 45 per cent tax rate for those earning more than £150,000 in the UK. Whatever the government does in the next term in the UK, what ministers do about tax increases will be paramount.

JP Morgan observes more money may need to be spent before the handover to the president-elect in the US, which has already changed the focus of its Toxic Asset Relief Program, also reports Barings Global Weekly Review, to amore UK-like approach of recapitalising banks and stimulating credit.


Governments are "tearing up the rule books", Standard Life says. Iceland, Hungary and the Ukraine have all sought help from the International Monetary Fund, whose head talked of financial stimulus of two per cent of each country's GDP, also espoused by the UK's prime minister, reported JP Morgan. The pre-Budget report in the UK represented a rescue package of £20 billion between now and April 2010, which amounted to half that, at one per cent of GDP.


On the back of bank underwriting, Threadneedle predicts investment in government and financial bonds as positive. Meanwhile a JP Morgan has seen bargain-hunting on the stock exchange. In its mid-month Weekly Strategy report, David Shairp wrote equities were good in the UK in 1975 when there were rumours of a coup to overthrow Labour and parts of the country had been reduced to a three-day week on the back of the miners' strike.

"Perhaps a simple lesson from history is that it is easy to become too pessimistic even when the current situation looks critical," he said.

Equities in the UK have outperformed all other classes since the Second World War making the markets look attractive, one city advisor said. Movement is likely to be sideways, said a JP Morgan, until the outlook clears, with October a "horrendous month" with high volatility. Investors have been opting for big caps over smalls in a presumed bid for safer collateral.

However, as interest rates look likely to creep lower from the central banks, Threadneedle advises avoiding speculation on currency and casting eyes elsewhere. So what is wrong with zero per cent? It could prove a move that helps the UK's Labour Party retain its lead accompanied by the stimulus measures in the next general election, help Obama "who will do what is necessary" earn his stripes and see Japan revert back to naughties conservative measures.

Zero interest rates would encourage spending and facilitate cheap lending. The interbank rates have put on a good show, JP Morgan stated mid-month. Although people may use a lower rate to sit tight and pay off debt, it would be a plus for people on variable rate mortgages. Something needs to be done and fast as governments get into the worst debt in history. Shooting too soon may be the only economy-saving measure.