Leading Article: We need to cushion the impact of this recession

Interest rate cuts are risky, but justified in the present climate

The stock market optimism that gushed forth after the recapitalisation of the banks has drained away almost as quickly as it arrived. The bears are back and they are more terrified than ever. The mass sell-off of shares in Asia continues. European shares indexes have plunged too. Our own FTSE 100 fell by 5 per cent yesterday. Value was heavily wiped from the Dow Jones. There is, of course, a good deal of herd panic involved in these trends. Fear feeds on fear.

But like the paranoiac under surveillance, the markets have some good reasons to be nervous. According to the Office for National Statistics, Britain's economy shrank 0.5 per cent in the last quarter, for the first time in 16 years. This explains the trepidation of investors in British companies. Yet we should not be parochial in our reading of the situation. What we are facing is a severe financial and economic crunch that will affect the entire world.

America and Japan, the planet's two biggest economies, are slowing. The same is true of France and Germany, the dominant economic powers of the eurozone. A host of smaller nations have been forced to call in the International Monetary Fund to avoid defaulting on their foreign debts. Even China, the great motor of world growth in recent years, appears to be slowing as orders from her overseas customers decline. The idea that China, along with rising nations such as India, Brazil and Russia, had somehow "decoupled" from the economies of the West has been exposed as wishful thinking.

The bottom line is that company earnings are going to shrink all around the world. That is why investors are selling stocks in them on such a scale. But what is bad for our companies is bad for all of us. A correction after the excessive borrowing and imprudent over-expansion of recent years is inevitable. But contracting economies are dangerous things. They inflict collateral damage in the form of rising unemployment, home repossessions and general impoverishment. A global contraction poses even greater dangers.

So the actions our governments take to cushion the downturn in the months to come will be crucial. Last week's global banking bailout was necessary to stop this global recession from turning into another 1930s-style slump. But a great deal more is needed to curtail this recession. At home, the theme of the week has been the need to cut small businesses some slack. There are also growing calls for the Bank of England to reduce interest rates to encourage the rest of us not to cut back our spending to damaging levels.

Rate cuts are not without dangers. They will erode the value of the pound, which is already falling on international currency exchanges. It would be irresponsible for the bank to ignore the possibility of a run by investors on our currency. Yet the risk of keeping rates where they are is almost certainly greater. And the good news is that our rates are, at present, higher than in many other monetary jurisdictions. In other words, there is room to cut. The Monetary Policy Committee should do so at its meeting next month.

The more immediate danger is that the high street banks will not pass on these cuts. This has been the pattern following recent rate cuts, which the banks have used to replenish their own depleted balance sheets, rather than transfer to ordinary borrowers. The Government, which now has a controlling share in our largest banks, needs to make it plain that this must end. There are larger issues at stake here than the comfort of our banks.