Rate cuts signal real recession fears

By cutting interest rates by a half-point today, the Bank of England has moved its preemptive campaign against recession up a notch.

That surprise was followed by another as the European Central also cut rates by the same margin.

It was the first time since February 1999 that the Bank of England's monetary policy committee (MPC) has cut rates by more than a quarter-point and it marks the seriousness of the spreading economic crisis.

In a statement after its meeting, the MPC said the economy had weakened by more than it had previously thought and a half-point cut was necessary to hit its inflation target.

At 4%, rates stand at a 37-year low as the bank tries its utmost to ward off the headwinds from the US, which is heading inevitably for recession after the September 11 attacks.

The move will delight unions and industrialists, who were clamouring for an aggressive move amid a deepening recession in manufacturing.

Official figures released on Monday showed that British manufacturing output fell at the fastest rate for nine years in September, while a sharp contraction in services renewed fears that the effect of last month's attacks in the US are spreading throughout the economy.

Digby Jones, the director-general of the Confederation of British Industry, who this week called for a half-point cut, said: "This was the decisive move that business wanted to give our economy a much-needed shot in the arm.

The global slowdown has put UK manufacturing into recession, which is now spreading to the service sector."

Interest rate cuts alone will not be able to cushion the UK against recession and industrialists are expecting some help from the Treasury.

The CBI points out that manufacturers remain under severe pressure and it is looking to the chancellor's pre-budget statement later this month "to give companies some breathing space and prepare the ground for them to take advantage of economic recovery when it comes".

The bank's move follows the US Federal Reserve's decision on Tuesday to cut 0.5% from rates in America. The European Central Bank jumped on the bandwagon by cutting rates by 0.5% to 3.25%.

If anything, the ECB's move was the more surprising of the day as it has been loath to reduce rates in recent weeks - to the despair of European finance ministers.

Constrained by tight public spending limits imposed by the EU growth and stability pact, European treasuries have limited ability to boost public spending to offset declining economic activity - a typical Keynesian manoeuvre.

So European finance ministers have cast increasingly anxious glances at the ECB and it has finally responded.

So far, so good. Aggressively cutting rates is exactly what is called for in the current situation. The worry now for the world's central bankers is that they are fast running out of options with rates this low.