The European Central Bank, the Bank of England and the Swiss National Bank delivered sharp rate cuts on Wednesday: 50, 150 and 50 basis points, respectively. However, central bankers are still in danger of succumbing to the “Canute syndrome”—failing to keep the receding tide of bank funding from leaving the economy high and dry.
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Overnight policy rates—3.25% in the euro zone, 3% in the UK and 2% in Switzerland—are low by recent standards. But, the US is at 1%. There will be more cuts in Europe if the financial and economic situation warrants. That looks increasingly likely.
Central bankers have abandoned all fear of inflation and all hope that the banks can manage on their own. Banks still won’t lend to each other, even at high rates, and are trying to shrink their lending to the real economy. That retreat is set to intensify in the face of mounting losses—house prices are still dropping sharply in the UK and problems in eastern Europe weigh on the euro zone.
The infant recession is both an effect and a cause of credit problems. Higher losses reduce banks’ ability and willingness to lend, and shrinking loans reduce economic activity. But the central bank rate cuts are not primarily anti-recessionary moves to stimulate lending. Along with central bank liquidity and government capital programmes, they are part of an effort to prevent collapse—to keep the financial system running. These cuts are impressive, but aren’t likely to do much. When borrowers and banks both want to get their leverage down, even negative real rates aren’t particularly alluring.
When Canute ordered the tides to stop, he didn’t actually think they would obey. The Viking king wanted to make the point that some forces were more powerful than the royal word. The battle between the monetary authorities and the financial tide is more evenly balanced. But the tide is winnng. The authorities will be lucky to get away with a mild recession.