DESPERATE TIMES call for desperate measures. Yesterday's interest rate cut of 0.75 per cent by central banks was a necessary reaction to an ever-deepening global economic crisis.
The European Central Bank (ECB) delivered the biggest rate cut in its history and the Bank of England lowered rates to 2 per cent, the lowest since 1951 and, indeed, since the bank's foundation in 1694. Last month the US central bank, the Federal Reserve, cut its benchmark rate to 1 per cent and may well lower rates again this month. This action by so many of the world's monetary authorities is welcome and overdue, particularly within the euro zone. It is designed to stem recession by stimulating economic activity and, hopefully, preventing a recession turning into something much worse - a depression.
The ECB's decision to cut its benchmark rate to 2.5 per cent reflects a remarkable change in policy within a short period as growth contracted sharply in euro-zone economies and the global economic outlook steadily deteriorated. In July, when the bank raised rates to 4.25 per cent, the ECB's primary concern lay with fighting inflation, then at 4 per cent. But with inflation dropping to 2.1 per cent in November, fighting recession and deflation was the ECB's primary concern yesterday.
Its policy shift in favour of monetary easing is a measure of how much the global economic landscape has deteriorated in a matter of months. This week the US economy was classified as having entered a recession a year ago. The International Monetary Fund (IMF) has forecast that economic activity in the US, Europe and Japan will contract next year. The developed world is facing its deepest economic slump since the second World War, economic analysts say.
In this context, yesterday's rate cuts were necessary but may yet prove insufficient to boost business and consumer confidence and to ease the tight credit conditions that have defined this global downturn. Central banks may have to cut rates even more aggressively in the months ahead to check the decline in consumer demand and business investment and to reverse the collapse in investor sentiment.
Nevertheless, the ECB's move provides some relief and hope - albeit too little and a bit too late. This rate reduction of almost one per cent will mean lower borrowing costs for business and lower mortgage repayments for homeowners. This assumes the banks pass on the rate reduction in full to their customers.
In Ireland, the ECB's monetary easing is particularly welcome. It comes at a time when the Government cannot contemplate a fiscal stimulus given the rapid deterioration in the public finances, highlighted again in November's exchequer returns. By contrast, in France yesterday, President Sarkozy announced a €26 billion spending package to mitigate the impact of the credit crunch on the French economy. That will raise France's forecast budget deficit to 4 per cent of GDP next year. Here, with the Government struggling to contain the deficit at under 7 per cent this year, yesterday's rate cut offers a measure of consolation in very difficult economic times.