The age of free money may be at hand.
As major central banks slash interest rates with unexpected speed, benchmark borrowing costs are now below inflation for the first time since the early 1980s, and policy makers are signaling they will go deeper.
The Bank of England and European Central Bank cut again last week, and the Federal Reserve and Bank of Japan are on the cusp of zero rates.
They're making a bid to shock life back into their recessionary economies and strained money markets, but it may be an uphill battle as consumers and businesses show greater interest in saving than spending, and as banks hoard capital rather than lend it.
"It's the race to zero," said Stewart Robertson, an economist at Aviva Investors Ltd. in London, which manages about $230 billion. "There's no obstacle to more rate cuts."
The U.K. central bank led by Governor Mervyn King slashed its benchmark rate to 3 percent Thursday, the lowest level since 1955. The reduction of 1.5 percentage points was the biggest in 16 years. The ECB followed with its second half-point cut in a month, dropping its rate to 3.25 percent. ECB President Jean-Claude Trichet declined to rule out further moves south.
The action in Europe followed cuts by the Bank of Japan and Fed last week. The Fed rate, which was dropped to 1 percent, hasn't been lower in a half-century. The Bank of Japan lowered its rate to 0.3 percent in the first paring in seven years.
Monetary policy is being eased because the 15-month credit crisis is inflicting harsher blows to growth and inflation than central bankers anticipated just two months ago.
The conundrum for central banks is their rate cuts may still not be packing a punch, even on top of record injections of cash and a willingness to accept lower-rated collateral for their loans.
"The problems in money markets are still quite severe," said Dario Perkins, an economist at ABN Amro Holding NV in London. "Market rates are above where central banks have their rates, and that's alarming them."
At the same time, companies and consumers are retrenching in the face of slowing growth and tighter credit. In the United States, the unemployment rate rose to 6.5 percent in October, the highest in 14 years, the Labor Department said last week.
Automakers and retailers are among the companies being battered by a collapse in consumer demand. In Japan, Toyota Motor Corp., the world's second-largest, forecast the biggest drop in profit in at least 18 years. Macy's Inc., Target Corp. and Gap Inc. all posted October sales declines in the U.S.
Another complication for central banks is that some financial institutions may be reluctant to pass on lower rates to borrowers.
The combination of cautious banks and reluctant spenders is forcing central banks to cut interest rates below inflation. JPMorgan Chase & Co. calculates inflation-adjusted borrowing costs in developed markets fell below zero last month for the first time since the early 1980s and are still declining.
Central banks are betting that negative real interest rates will induce people to spend rather than save money that is declining in value, economists said. The strategy also aims to jolt investors and banks into seeking higher yields by making riskier long-term loans.
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