Britain may need to adopt zero interest rate rule

By Matt Falloon  |   2008-12-19  |     NEWSPAPER EDITION

ZERO interest rates in Britain are a possibility and further capital injections may be required in the banking sector, Bank of England Deputy Governor Charles Bean said.

"We have to recognize that it's a possibility," Bean told the Financial Times newspaper yesterday.

"Of course, interest rates, the bank rate, is still at 2 percent, so we still have some margin to go yet, but we may find ourselves getting them all the way to near zero." The central bank has slashed interest rates by 3 percentage points since October and markets expect further cuts as Britain slides into its first recession since the early 1990s. Bean said the outlook for the United Kingdom economy was getting worse.

The United States Federal Reserve this week lowered interest rates to between zero and 0.25 percent.

"It's a moot question whether you actually want to go all the way to zero, or stop at a small positive number; it really depends on how the money markets operate," he said.

"And the problem with going to zero is that effectively you don't leave the banks very much incentive to manage their own liquidity."

Policy makers have warned that rate cuts may not be having as much of an effect on the economy as they would do in more normal circumstances because of the impact of the credit crunch, raising speculation that more unusual measures may be needed. Bean said any action to increase money supply through the purchase of assets the central bank might undertake would need to be coordinated with the Treasury and Debt Management Office, which issues government bonds.

"The substantive questions in relation to so-called quantity easing relates to what assets you want to purchase," he said.

Bean also said more action by the authorities may be needed to get banks to increase lending because of the damage being done to businesses through a lack of credit.

"The really central question is to what extent banks around the world cut back on their lending to households and particularly businesses," he said.

"Clearly the more they do that, the faster they try and deleverage, the deeper the downturn may be."