UK Interest Rates

Bank of England Base Lending Rate - 0.5%

The BoE dropped Base Interest rates in Spring to 0.5% where is remained throughout the year. But is this good news?

Tha Base Rate is a guide to what interest you and I should be charged on our borrowing, but it doesn´t quite work like that does it? But it should help companies, individuals and especially Banks through what was a very difficult year for the economy.

If the High Street Lenders passed on the rate reductions as instructed by the Chancellor, and that is a pretty big IF (Actually a NOT) , then it should help UK businesses and homeowners through the troubled times ahead.

However, there is a down side, it also effects everyone with savings, pensions, investments etc. in a negative way, not to mention it will likely further devalue £Sterling etc. Only time will tell if recent slashing of interest rates will be judged as good or bad news. (OI remain unconvinced.)

Moving the base rate has traditionally been a simple and visible way of manipulating the economy. However, given the unprecedented financial situation, how effective are interest rate cuts?

More concerning for us is ´What if it doesn´t work?´ and then ´What´s the next step?´....

What if they keep on cutting rates, until they reach zero, like in the USA,?? Are we doomed to repeat the stagnation of the Japanese economy of the 90´s? Which some economists argue prolonged the situation for years.

The consequent action has been to increase liquidity (Money flow) by printing more of it! £170billlion so far! it´s called  ´Quantatitive easing´. That will inject money in the short term, but longer term it could be the path to absolute meltdown. Particularly if the Rating Agencies start to question or even downgrade UK gilts from their prime position (AAA)?

Ultimately, it could lead to a situation like Zimbabwe, where inflation is running at 1,000 percent plus! Where the price of daily necessities rise on an hourly basis. Where monthly income is devaluing at such a rate, people can´t afford the basics. The huge increases in food costs last year in the UK could get a lot worse.

OK. It´s hypothetical, but not completely out of the question?

It doesn´t appear to have had the desired effect on mortgage lending yet as figures show lending down around 60% on 2008. There has been an increase since the crash of 2007, but the numbers are too low to hold the property market and subsiduary employment markets up.

The European Central Bank cut 0.5% off its base lending rate, following the BoE. In the USA, the Fed have reduced the base rate to between Zero and 0.25%. meaning they have hit rock bottom. It will be interesting to see how the US economy reacts? To date, it doesn´t seem to have effected the overall economy, but these measures take time.

So far, many Banks appear reluctant to pass on the cuts to their customers, most Standard Variable Rate Mortgages are still way over the base rate, so why are the Banks being so greedy? It probably has more to do with confidence, or lack of, than margins, as given the large differential between saving rates and lending rates it should be a ´licence to print money´ for the Banks (According to one Bank source!).

As Base rates fell, so did overnight LIBOR, which indicates more fluidity in the market as Banks are more open to lending to each other. However this changes constantly and can be effected by a multitude of influences.

So far, it appears these measures have not yet had the desired effect of avoiding recession or halting the house price slide which continues overall, with only a few prognosticators (NOT Housebuilders or Mortgage Lenders) suggesting a recovery any time soon, should the MPC look at further reductions in the base rate or just print more money? I know which option this Government will choose....BOTH!

Previously:

November 08 - the Monetary Policy Committee (MPC) for the BoE decided to drop the Base rate to 3.0% in accord with a number of other central Banks. The ECB set the European rate at 3.25% (Down 0.5%) Interestingly, this is the first time the UK rate has been lower than the Euro rate.

Politicians and some economists called on the Govenor to lower the Rate lowered to help the public & businesses in these difficult times. However, the MPC has a primary responsibility for inflation and shouldn´t be persuaded by popular opinion, but they dropped one and a half percent in an effort to steady the volatile stock market & stimulate an economy in reccession .

Current figure for Inflation (CPI) is still more than the Governments target of 2%. Usualy this means the Committee should be looking to increase rates to stop prices rising. However, recent figures convince some economists inflation has peaked and wholesale food and Oil prices will continue to fall.

Good News for Homeowners?

Not entirely. This still won´t necessarily make any difference to your mortgage in the short term. Those on ´Tracker Mortgages´ will hopefully see a benefit this month, but others will still have to rely on LIBOR, which has only passed on part of the base rate cuts in recent months.

Capital Economics said "Worryingly, the economic downturn has only just got going. Interest rate cuts will not be enough to stop the correction, nor slow the pace of house price declines. We expect house prices to fall a further 20 per cent in 2009."

So does this show the Governments £38billion rescue package is working?

There isn´t yet a conclusive answer, but it looks as if some of the numbers are moving in the right direction. The Stock market looks as if it´s showing signs of a recovery from the recent turmoil, which some Bankers and media described as ´Carnage´. It´s early days as the financial world is still on ´Life Support´, but it certainly looks better than it did a couple of weeks ago. However, this huge base rate cut might have a negative effect on the Share markets.

If this Rescue Package is the point at which the global financial crisis starts a recovery, it could be the turning point in Gordon Browns fortunes as Prime Minister......

However, In Our Humble Opinion, slashing the Base Rate is not the answer in this current situation, Looking back in history (Japan in the mid 1990s) and more recently in the USA, lowering interest rates alone will not solve the issues of Credit/Commodity Bubbles that have burst.

Look further back in history to the 1930´s, and the Keynesian policy of lower interest rates and increased public spending did not stop recession, it prolonged it whilst arguably softening the depth of the depression. However, 20 years later, many Economists blamed the depression on this very policy and have since followed a policy of Capital Markets for the remainder of the century.

Mortgages

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