Zero Interest Rates Looming

I can see Japan from my house!

Bloomberg: As major central banks slash interest rates with unexpected speed, benchmark borrowing costs are now below core inflation for the first time since the early 1980s, and policy makers are signaling they will go deeper.

Yesterday’s cuts by the Bank of England and European Central Bank, which came with the Federal Reserve and Bank of Japan on the cusp of zero rates, are a bid to shock life back into their recessionary economies and strained money markets. It may be an uphill battle as consumers and businesses show greater interest in saving than spending, and banks hoard capital rather than lend it.

“It’s the race to zero,” said Stewart Robertson, an economist at Aviva Investors Ltd. in London, which manages about $230 billion. “There’s no obstacle to more rate cuts.”

The U.K. central bank led by Governor Mervyn King yesterday axed its benchmark rate to 3 per cent, the lowest level since 1955. The reduction of 1.5 percentage points was the biggest in 16 years. The ECB followed with its second half-point cut in a month, to 3.25 per cent, and President Jean-Claude Trichet declined to rule out further moves south.

The action in Europe, which extended to reductions in the Czech Republic, Switzerland and Denmark, followed decisions last week by the Fed to drop its key rate to 1 per cent, matching the lowest in a half-century, and the Bank of Japan to cut to 0.3 per cent in its first paring in seven years. The central bank of South Korea today cut its benchmark for a third time in a month.

…Rapid rate cuts are intended to avoid the fate of Japan, which endured a decade-long slump after its asset bubble burst in 1990 in part because its central bank was “initially too timid and too slow to react,” economists at Deutsche Bank AG said in a report yesterday.

As rates fall further, central banks will have to consider less conventional steps to cushion their economies. Among them: making a public commitment to keep rates low, and lowering long- term borrowing by pumping large amounts of cash into banks with direct purchases of government securities.

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