Today's interest-rate reduction illustrates just how distorted economic policy has become. Inflation is rising; the exchange rate is dropping like a stone; and economic growth, at least for the moment, remains comparatively strong. In short, as far as the real economy is concerned, there is no justification for reducing rates.
Yet, interest rates are coming down. In a straight contest between the real economy and the financial sector, there is only one winner. Banks are screaming for lower rates. If the banks want something, the Bank of England is invariably prepared to give it to them.
While the MPC was cutting rates, mortgage lenders were hiking them. Today, the Alliance & Leicester pushed rates up across their entire mortgage range between 0.2-0.35 percent, while the Nationwide raised rates on their fixed-rate mortgages by between 0.12-0.32 percent.
This combination of lower base rates and higher lending rates give us a clue as to what is really going on. The Bank of England and the financial sector are trying to increase spreads in the hope of boosting profitability. Savers will receive lower interest payments on their deposits, while borrowers will pay more, assuming that they can find a bank prepared to lend money.
This policy is in effect a backdoor bail out. Savers will now have to subsidize the banks and their stupid lending decisions. Default rates are about to rocket and banks need the extra cash to cover the losses.
This crisis revolves around distributional question; who will pay for the huge losses now sitting on the balance sheets of the banking system? Today, the banks moved closer to their goal of ensuring that they pass the costs of this crisis onto the rest of us.