Still not convinced there’s a serious global economic slowdown in the works? Look no further than actions by key central banks in the last few days. By any measure, interest rate reductions were huge, a needed boost to the economy. But they also suggest more bad news to come.
The drama was intense last Thursday. The Bank of England cut rates by 100 basis points, hard on the heels of a 150 basis point cut last month. Thailand matched the cut, while the Reserve Bank of New Zealand sawed off 150 basis points, and the Swedish Riksbank topped everyone with a cut of 175 basis points. Even the European Central Bank, which was still raising rates in July, chopped 75 basis points from the official rate. And yesterday, the Bank of Canada continued a string of rate reductions with an unusually large 75 basis point cut. Quite a week, all told.
Rate cuts of this magnitude are relatively rare. Whether tightening or easing monetary policy, a more typical path is a series of smaller movements, aimed at reining in runaway growth or engineering a soft landing. In its short history, the European Central Bank’s action on Thursday was unprecedented. Canada has only made two single-session rate changes comparable to Tuesday’s cut since explicit inflation targets were instituted. U.S. rates were slashed in 2001, but no single reduction matched the two 75-basis-point cuts seen in January and March of this year. And for back-to-back British cuts like we’ve just seen, you have to go back to the early 1980s.
The total extent of recent easing is also dramatic. The cuts that we have seen to date already rival actions taken in past recessions: 425 basis points in the U.S., 375 basis points in the UK and 300 basis points in Canada. The ECB, late to the game, has already managed to cut by 175 points. But what is also interesting is the current level of policy rates: in the U.S., matching the historical low of 1% in 2003-04, in Canada, at a 50-year low of 1.5 per cent, and at 2.5 per cent and 2 per cent in the European Union and the UK, respectively.
The magnitude of change is even more dramatic given the preoccupation of central banks earlier this year. Spiking commodity prices sparked fears of price hikes in the broader economy, putting thoughts of monetary easing on hold, and raising the prospect of rate increases. The subsequent plunge in prices erased those fears, but the delay to the easing cycle was unfortunate, given the way economic prospects for 2009 are unfolding.
The recent dramatic rate actions are needed economic stimulus, but the timing and impact are at this point unclear. First, monetary policy takes time to affect the real economy. It will be the middle of next year before the most recent rate movements show up in real activity, although the effects of earlier rate cuts will have begun by then. Second, market rates have been slow to move with policy rates, delaying the impact on real economic activity. And third, financial institutions have tightened lending practices considerably. Funds may cost less, but access has deteriorated.
The bottom line? Recent rate cuts are a needed remedy in what has swiftly become a very slow economic environment. The dramatic moves reinforce diminished expectations for 2009. The broadly-shared hope is that the rate cuts will be as effectual as they are dramatic.
The views expressed here are those of the author, and not necessarily of Export Development Canada.