3 December 2007

Pleas for rate cut as interbank loans dive

By Ambrose Evans-Pritchard, International Business Editor
Last Updated: 6:27am GMT 03/12/2007

The sterling interbank market has collapsed at the fastest rate in modern history, prompting pleas for immediate rate cuts from a chorus of top British economists.

Office for National Statistics data sourced to the Bank of England shows the volume of market loans in the banking system plunged from £640bn at the onset of the credit crunch in August to £249bn by the end of September, suggesting British lenders have been hit even harder than US banks in relative terms. Total sterling assets dropped from £3,244bn to £2,876bn.

"This is one hell of a shock to the financial system," said Professor Tim Congdon, a leading monetarist at the London School of Economics.

"A market that has taken 30 years to build has completely imploded in a matter of months. Lenders have been squeezed savagely. We've moved into a different era," he said.

Mr Congdon called for a half-point cut to the interest rate to 5.25pc when the Monetary Policy Committee meets this week, warning that the M4 money supply is slowing fast and might contract over the next six months.

Patrick Minford, a professor at Cardiff University, called for a three-quarter point cut, accusing the MPC of "standing idly by" as three-month Libor spreads rocketed by 75 basis points - a severe tightening of credit.

"I regard the Bank's behaviour as highly irresponsible, neglecting a century of monetary teaching from Bagehot on. It is time for some sense to prevail. The Bank look like fools," he said.

The hard-hitting comments were contained in the minutes of the Shadow MPC (SMPC), a group of economists who take the pulse of the economy prior to each MPC vote under the aegis of the Institute of Economic Affairs. SMPC member Peter Warburton, from Economic Perspectives, called for a half-point cut, with further easing in the New Year.

"A profoundly deflationary credit downturn has taken hold," he said. "Recent weeks' dramatic events have infected urgency into the situation."

David Smith, a professor at Derby University and chair of the SMPC, defended the Bank's wait-and-see approach. "The MPC is walking along a narrow and dangerous Alpine ridge in a blinding blizzard. They can't see anything," he said. "People assume that the risk is a credit implosion leading to a second Depression, but there is also a serious risk on the other side of the ridge in terms of inflation.

"The British economy was red hot in the third quarter. RPIX inflation is at 3.1pc. If you look at oil prices, commodities or gold, there are many signs this is like the early 1970s," he said.

"Has the economy suddenly and totally fallen out of bed? We don't know yet, and it would be dangerous at this stage to bet it has. There is a risk rates will have to go up next year, not down," he said.

Most City economists expect the nine-strong MPC to hold rates steady when it meets on Thursday. Sir John Gieve, the Bank's Deputy Governor, and David Blanchflower voted for a quarter-point cut in November, fearing that the property market was starting to buckle.

Credit conditions have tightened abruptly since then, driving Libor back to crisis levels of 6.60pc. The Nationwide house price index dropped 0.8pc in November, the steepest fall in 12 years.

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