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Market fears Bank of England has lost control of rates

Via NY Transfer News Collective  *  All the News that Doesn't Fit
 
The Telegraph - Dec 7, 2007
http://www.telegraph.co.uk/money/main.jhtml;jsessionid=Q4TA5UE2GURWRQFIQMGSFF4AVCBQWIV0?xml=/money/2007/12/07/cnbank107.xml


Market fears Bank of England has lost control of rates

By Edmund Conway

There were fears in the City last night that the Bank of England
has lost control of monetary policy after expectations for money
market borrowing costs rose -- despite the Monetary Policy Committee
cutting interest rates.

Experts warned that it was a sign that the credit crisis could
escalate over the Christmas period, even though the Bank has now
embarked on a major series of interest rate cuts for the first time
in almost eight years.

It coincided with a chilling warning from the Organisation for
Economic Co-operation and Development that the UK economy is heading
for a major slowdown next year -- and possibly a "significant slump"
in house prices.

This month's short sterling futures, which indicate where the market
expects the key benchmark interbank borrowing rate to be in two
weeks' time, actually rose markedly after the Bank's decision --
an almost unprecedented reaction. The pound also ended the day up
slightly on its trade-weighted index -- another highly unusual
outcome on the day of an interest rate cut.

John Wraith of Royal Bank of Scotland said: "They haven't got the
control over rates in the financial system that they ordinarily
have.

"Historically, a 25-basis point change in Bank rate would lead to
an almost identical change in Libor" -- the benchmark rate in the
money market. "That hasn't happened."

He said this made it highly likely that the Bank would eventually
be forced to cut rates even further than anticipated. A swathe of
economists predicted borrowing costs could now drop to as low as
4.5 percent or below by the end of 2008.

Peter Spencer, chief economic adviser to the Ernst & Young Item
Club, said: "The fact of the matter is that the market rather than
the Bank is now dictating monetary policy -- and not from the point
of view of controlling inflation, but from the point of view of a
random walk. It is behaving in a way which is totally rational for
individual banks but adds up to a major deflationary issue.

"I think this is a very grave situation indeed -- and not just for
the 1.5 million" households due to renew their mortgages next year.
"If this problem is not sorted out in the next two to three months,
we are looking at major insolvencies in UK plc."

The sense of fear in the City was compounded by the severity of the
Bank's brief accompanying statement, which said: "Conditions in
financial markets have deteriorated and a tightening in the supply
of credit to households and businesses is in train, posing downside
risks to the outlook for both output and inflation further ahead."
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