0% interest rate on the horizon as economy shrinks twice as fast

From The TimesDecember 10, 2008

0% interest rate on the horizon as economy shrinks twice as fast

Gary Duncan, Economics Editor, and Philip Webster, Political Editor
Alistair Darling’s hopes that growth would resume in the second half of next year were hit yesterday by predictions that the recession could turn into a slump worse than that of the early 1980s.

Experts said that the economy would shrink by 1 per cent or more this winter as it emerged that British industry is contracting at the fastest pace since 1991.

Output from factories, power stations, mines and the North Sea plummeted in October by 1.7 per cent, leaving it 5.2 per cent down from levels a year earlier.

The speed at which the economy is shrinking has doubled to at least 1 per cent in the past three months, from an already severe 0.5 per cent officially reported for the third quarter, according to the National Institute of Economic and Social Research.

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The figures increased expectations that the Bank of England will cut interest rates by a further full point to an unprecedented low of 1 per cent next month. A base rate of zero, or close to it, is no longer seen as improbable or even unlikely.

The latest grim economic news came as the political divide over the recession widened sharply, with David Cameron announcing that he would not match Labour’s new spending plans for 2010 and beyond, as set out in the Pre-Budget Report. The Tory leader was accused by Mr Darling of unbelievable complacency after saying that he would make further savings in the Government’s revised spending plans and would go beyond the £5 billion in extra efficiency savings announced then.

Mr Cameron blamed the need for lower spending on “the mess Labour have made”. He said that the Tories had spent the fortnight since the Pre-Budget Report studying the Government’s figures and cited concerns about assumed future tax revenues. “To pay for Labour’s spending would mean substantial tax rises over and above those that the Chancellor actually told us about,” he said. “If we are to avoid substantial tax rises in the future — tax rises that will hamper the recovery — we must slow the growth of government spending.”

But Mr Darling responded: “I cannot believe that it is right that we should stand back and, as he seems to be implying, let the recession take its course.”

The Tories were out of line with most of the rest of the world, including Barack Obama, the US President-elect, in their response to the downturn, he said. “I’m sorry that the Leader of the Opposition seems not only to be taking a different track from us but also actually saying he would take money out of the economy now, because he said he wanted to see action to reduce borrowing now. I challenge him to tell us where is he going to take money out of the economy.” He also dismissed the Tories’ call yesterday for an immediate general election, insisting that ministers were focused on the challenges facing the country. “That’s what we should be concentrating on — that and nothing else,” he said.

However, the credibility of the Chancellor’s hope that steep interest rate cuts and his £20 billion giveaway would deliver a rapid turnaround in the economy was undermined by one of the men who sets the Bank of England’s base rate. Andrew Sentance said that the recession was set to be at least as bad as Britain’s three previous postwar recessions — in the mid-Seventies and the early Eighties and Nineties. “I now expect the recession to be of comparable depth to those previous downturns,” said Mr Sentance, an external member of the Bank committee that sets interest rates.

As Mr Darling prepared for questioning by MPs about his forecasts this afternoon, his chief economic adviser admitted that the prediction for growth would resume in the second half of next year depended on banks ending the lending drought. “We are conditioning \ on credit conditions returning to a new norm,” David Ramsden told the Treasury Committee. He defended the Treasury’s forecasts that the economy would grow by as much as 2 per cent in 2010 and rejected MPs’ charges that its projections were “Noddy economics”.

He insisted that both the Treasury and the Bank of England were justifiably betting that growth would be rekindled by a combination of tumbling energy prices, drastic interest rate cuts, the falling pound, the “fiscal stimulus” of lower VAT and a short-term rise in public spending.