Fear of long recession prevails as rate relief fails to materialise

BUSINESS leaders last night welcomed the decision to slash interest rates by 1.5 points, but expressed fears that the cut would not be passed on to struggling small companies.

Despite the dramatic move by the Bank of England, which takes the cost of borrowing to a 53-year low, the City was hit by a fresh sell-off.

The FTSE 100 closed 5.7 per cent or 258.3 points lower at 4,272.4, wiping some £62 billion from the value of the UK's biggest companies, amid concerns that the economy is still heading for a protracted recession.

Richard Hunter, head of equities at broker Hargreaves Lansdown, said: "In normal circumstances, whatever they are these days, you would have hoped for a more positive sustained reaction to such an extraordinary rate cut. But the economic and company earnings data remains gloomy and the market knows we are still going to enter a recession."

The Federation of Small Businesses (FSB) said the rate cut, to 3 per cent, could represent a saving of £750 million for small businesses on loans and overdrafts. But it warned that the benefits needed to be passed down to companies by banks for the economy to notice a difference.

FSB chairman John Wright said: "We called for a bold 1 per cent cut and this unexpectedly large rate cut will make an enormous difference to small firms and will put money in people's pockets before Christmas.

"But all this will come to nothing if the banks do not follow through and pass on the rate cuts to those small firms struggling with increased costs of credit."

John Johnston, director of institutional sales at brokerage Seymour Pierce, said it was too little too late for smaller companies, particularly those with debt problems. He said: "They (the monetary policy committee] are at least three months behind … they should have been more proactive and now they're playing catch up."

Smaller companies, which usually lack the international focus that allows larger groups to hedge their risks across markets, have been hard hit in the downturn.

Stuart Porteous, head of RBS group economics, said: "Extraordinary times require extraordinary actions. The rate cut is unprecedented in the history of the MPC. Markets were crying out for something bold and the MPC has delivered."

Organisations called for inter-bank lending rates to be cut in line with the reduction in the base rate. The key interbank lending rate, the three-month Libor, fell to 5.56 per cent yesterday, but it remains a massive 2.56 percentage points above the new base rate, and well up on its typical pre-credit-crunch range of between 0.15 per cent and 0.2 points above base rates.

Andrew Milligan, head of global strategy at Standard Life Investments, said economists would be looking to next week's inflation report from the central bank for signs of an even deeper recession than expected and how far inflation may fall in 2009.

He said: "Many people will ask: what does the Bank know that the rest of us don't?"

The European Central Bank yesterday reduced its benchmark interest rate by half a point to 3.25 per cent.