How low could interest rates go?

It took the Bank of England a while to act on the shrinking economy, but now that inflation has peaked the central bank appears to be well and truly committed to cutting interest rates. In October it cut the base rate by 0.5% to 4.5%, in November it unveiled a surprise 1.5% cut to 3% and in December it unveiled a 100 basis point cut bring the base rate to just 2%.

But interest rates could fall even further in 2009. Capital Economics says it expects the Bank of England to cut interest rates to 1% or below as a result of the anticipated recession next year and general credit crunch-afflicted economy. However, it does not yet know how long rates will stay at this historically low level.

The firm of economists is known for its bearish outlook, and this forecast is lower than other commentators expect. However, Capital Economics argues that the “extraordinary circumstances require extraordinary actions”.

Against a background of negative economic growth, falling house prices, turmoil across global stockmarkets, and continued pressure on banks and other financial institutions exposed to bad debt, Capital Economics believes the central bank’s MPC will need to cut interest rates in the UK to "extremely low levels".

Jonathan Loynes, chief European economist at Capital Economics, says: “Given that the UK’s problems would seem to be at least as severe as those in the US, UK interest rates should arguably be close to US rates."

Loynes adds that it is not impossible to imagine the rates could fall even lower than 1%, perhaps even to zero.

Now that the US Fed has cut interest rates to between 0% and 0.25%, this is more than possible.

Loynes says December's minutes, along with rising unemployment, pave the way for the MPC to follow the US Fed and cut interest rates very close to zero.

“The minutes confirmed that all nine members voted for the 1% cut in rates to 2%,” he adds. “What’s more, they would have voted for an even bigger cut were it not for concerns that it would undermine confidence in the economy and prompt an ‘excessive’ fall in the exchange rate.

“At the very least, another cut in rates in January looks very likely and is unlikely to be the last.”

Catherine MacLeod, chief economist at BDO Stoy Hayward Investment Management, says the gloomy economic horizon justifies another cut in interest rates.

"The economic data is certainly suggesting that we are in at least as tough an economic climate as the early 1990s," she says. "The recession is inevitable, but lower rates could help mitigate the problem – in essence, the Bank of England is running to stand still – but is at least not falling behind. We expect that rates will continue to fall towards 1%."

With still no signs of mortgage lending returning to anything near the levels enjoyed in 2007, Jonathan Turpin, chief executive of, says rates must fall further.

“The recent pre-Budget report offered little in direct support for homebuyers so we now need to see a combined effort from the Bank of England, the banks and building societies to facilitate lending,” he adds.

David Bexon, managing director of, agrees: “The MPC held off for a long time before a significant slash in rates, and credit remains extremely tight."

So, what do lower interest rates mean for households in the UK, from savers to mortgage borrowers?


For savers, interest rate cuts are not good news. If your savings account is variable then it is liable to move down as the base rate goes down. Having said that, following October’s base rate cut, a few savings banks didn’t reduce their variable rates. There is, of course, no guarantee the same will happen down the line.

If your savings account has a fixed rate, then you won’t be directly affected.

However, bear in mind that a climate of falling interest rates makes fixed deals look all the more attractive, and providers have already responded to 2% being shaved off the base rate by pulling deals and slashing rates.

A lot of variable rate savings accounts come with Bank of England guarantees. These mean that although the rate tracks the base rate, it will not fall below a certain level. Opting for a savings account with this sort of guarantee should offer savers some security during the next year.



After November's 1.5% cut, 92% of savings providers slashed their rates by the same amount or more according to data provider Moneyfacts. A similar response is expected in rates are cut again in December.

On the plus side, savers should remember that lower interest rates are designed to help the UK weather the recession.

In the current climate, many savers are opting for security and ease of access over rate. This is a tough trade-off, and it will depend on your own circumstances and confidence in British banks whether you go for fixed-rate (where any access could see penalised) or variable rate.


Generally speaking, lower interest rates should be good news for mortgage borrowers. People with tracker mortgages, where the interest rate literally tracks Bank of England base rate, should see their monthly repayments reduce each time the rate is cut.

However, borrowers on a standard variable rate mortgage (SVR) might not be so lucky. Although SVRs should also rise and fall in line with the base rate, lenders do not have to pass on the benefits of lower rates – and many have recently indicated they are less than willing to do so.

Following October’s 0.5% cut, only around 25% - 30% of lenders reduced their SVRs, with some passing on smaller reductions and the remainder not cutting rates at all. Following an outcry, several of the top lenders were quick to pass on November's cut in full, but 75% still failed to reduce their SVRs in line with the base rate cut. And there is no guarantee they will pass on any cut seen in December.

Lenders say they can't keep cutting rates as the cost of inter-bank borrowing remains high.

But Peter Vicary-Smith, chief executive of Which?, says: “Banks have been having their cake and eating it for too long. The Industry claim that their hands have been tied when it comes to passing on rates to SVR mortgage customers because they borrow at the Libor rate rather than the base rate.

"However, since the 5 November, Libor rates have fallen by significantly more than the base rate*. So, what are they waiting for? Banks have been benefiting from this Libor cut and to date, none of them has passed on the full cut.”

Bank not passing on base rate cuts to SVR is bad news for many borrowers. Pre-credit crunch, the advice to homeowners was never to sit on an SVR but instead remortgage to another fixed or tracker deal with the same lender or elsewhere.

However, the current climate means that increasing numbers of people have now been forced to remain on their lenders’ SVR, either because they are in negative equity as a result of house price falls or because their credit record makes them sub-prime and, therefore, higher risk in the eyes of banks.

There is another concern for borrowers with tracker mortgages. Lenders such as HBOS, Nationwide, Abbey and HSBC all impose minimum tracker rates, which means borrowers' rates will either never go below a certain level (normally 3%) or the bank will stop reducing the rate if the Bank of England's base rate falls below a certain level (again, normally 3%)

Ray Boulger, senior technical manager at John Charcol, explains: "Minimum tracker levels have only just emerged as an issue because previously the base rate wasn't expected to fall as low as economists now expect. However, banks that have these limits will stop passing on the benefit of lower interest rates at a certain point, which is bad news for many tracker borrowers."

And if you are a Halifax borrower, then a clause in its terms and conditions could pose even more problems for you down the line.

Halifax reserves the right not to pass on base rate falls below a certain level – 3% in its case. However, it is unique in the fact that it reserves the right to revert to the normal technique of pricing trackers - and therefore increase the rate borrowers pay.

For example, if a tracker mortgage borrower pays Bank of England base rate plus 1%, and the base rate is 3%, then their pay rate will be 4%. If the base rate falls to 2% then Halifax does not have to pass on this 100 basis point saving, meaning the borrower continues to pay 4%.

If the base rate then rises back to 3%, Halifax reserves the right to increase the pay rate by a full percentage point – meaning the borrower’s pay rate is now 5%.

So, although their mortgage is base rate plus 1%, they are actually paying base rate plus 2%.

If you are on a fixed-rate mortgage, then lower interest rates won’t make an awful lot of difference to you immediately as your rate is guaranteed for a set period of time.