Bank of England cuts interest rates to 5%
The Bank of England has taken action to ease pressures on the housing market by cutting interest rates by a quarter of a percentage point to 5%.
The latest cut brings interest rates to their lowest level since December 2006. The Bank of England's Monetary Policy Committee - which sets interest rates - says the deteriorating housing market warranted a cut in interest rates, despite evidence that inflation will increase in the medium term.
The cut comes amid mounting evidence of a prolonged housing market slowdown. Housing market data reveals continuing monthly falls in house prices, and with mortgage lenders continuing to restrict their lending activity more people are struggling to secure finance to get on the property ladder.
In response to the cut, Nationwide and Halifax have already reduced their standard variable rates by 0.25% but it is not certain that all lenders will pass the cut on to their customers, as margins are already tight.
Mortgages that track the base rate will also reduced in line with the cut.
However, lower interest rates may not necessarily be reflected in new mortgage rates.
Jonathan Cornell, managing director of brokerage Hamptons Mortgages, says new borrowers are unlikely to feel any benefit from the interest rate cut.
He said: “The majority of lenders price their products based on the cost of borrowing from other financial firms at a rate of interest known as Libor. This is now nearly 1% above the Bank of England base rate. Lenders that do cut their mortgage rates therefore risk borrowing at a higher rate of interest than they lend at.”
He also predicts that it could be months before fixed rate mortgage get any cheaper: “Fixed rates haven’t peaked yet as demand exceeds supply.
“If the number of people borrowing mortgage continues to slow then this should bring fixed rates down, as lenders will want to attract new customers and increase their business levels. But at the moment, getting new mortgage customers isn’t a priority for many firms. Cheaper mortgages could be months away.”
Tim Fletcher, sales and marketing director of Baseline Capital, agrees the cut is "irrelevant" for new mortgage borrowers. He said: "Any change in the base rate now is likely to have little or no impact on the cost of raising funds for lenders."
The Bank of England’s vote comes amid the news that the pound has fallen to 80p against the euro for the first time. The International Monetary Fund (IMF) has also warned of a sharp slowdown in the growth of the UK economy.
It predicts a sharp slowdown of growth to 1.6% in 2008 and 2009, significantly below the Treasury's estimate for 2% growth.
The IMF also warns that the growth of the global economy will slow to 3.7% in 2008 and 2009 - 1.25% lower than growth in 2007.
And it predicts the US will go into a “mild recession".
The slowdown in growth is a direct result of the sub-prime credit crunch, which started in the US and quickly spread to the UK and other countries.
The IMF has forecast the losses from the credit crunch could reach $945 billion (£472 billion) or higher this year.
The housing market slowdown was likely to be a key consideration for the Bank of England. The latest figures from Halifax show house prices fell by 2.5% in March, and more lenders have put up rates and restricted lending to people without deposits.
One bit of good news is the announcement from HSBC that it will match rates for people coming off fixed-rate deals over the next five weeks. But the offer does not offer a silver bullet solution for everyone.
The cut in interest rates may not be welcomed by savers with variable rate accounts.
Adrian Coles, director-general of the Building Society Association, says savers are likely to continue to see competitive rates.
This is partly because most banks and building societies are keen to increase retail deposits in order to improve their balance sheets and even help fund new mortgage lending.
Coles adds that saving accounts still represent lower risk than investing in shares.
While the Bank of England was busy cutting interest rates, the European Central Bank (ECB) froze rates at 4%.
Tom Elliott, gloabal strategist at JPMAM, explains that on the surface both the ECB and the Bank of England face similar predicaments - rising inflation balanced against slowing economies plus interest rates far higher than in the US and Japan.
But, he says on closer inspection the Bank of England seems more concerned about easing the impact of closed credit markets, while inflation is at the forefront of its continental counterpart's mind.
Elliott said: "The currency markets have taken a very different stance towards the two regions. The euro has strongly appreciated in recent months, reaching another high against the US dollar, while sterling’s performance has been, well, less than sterling. Interestingly, headline inflation in the eurozone is also running almost one percent higher than in the UK, despite the strong euro.
"Importantly, the sources of economic slowdown appear to differ. In Germany, the impact on real household incomes from surging food and energy prices seems to be a greater factor than the tightening credit market. This is reasonable enough, given that German households, and corporates, are net savers, and the German mortgage market is far less exposed to variable rates.
"Meanwhile, the UK is suffering more from tighter credit conditions, with households significant net debtors."
Monetary Policy Committee
A committee designated by the Bank of England to regulate interest rates for the UK. The MPC attempts to keep the economy stable, and maintain the inflation target set by the government and aims to set rates with a view to keeping inflation at a certain level, and avoiding deflation. The MPC meets on the first Thursday of each month and discusses a variety of economics issues and constitutes nine members: the governor, the two deputy governors, the Bank’s chief economist, the executive director for markets and four external members appointed directly by the Chancellor.
All sub-prime financial products are aimed at borrowers with patchy credit histories and the term typically refers to mortgage candidates, though any form of credit offered to people who have had problems with debt repayment is classed as sub-prime. Depending on the lender’s own criteria, sub-prime can apply to borrowers who have missed a few credit card or loan repayments to people who have major debt problems and county court judgments (CCJ) against their name. To reflect the extra risk in lending to people who have struggled in the past, rates on sub-prime deals are typically higher than for “prime” borrowers.
The London Inter-Bank Offer Rate is the rate at which banks lend to each other over the short term from overnight to five years. The LIBOR market enables banks to cover temporary shortages of capital by borrowing from banks with surpluses and vice versa and reduces the need for each bank to hold large quantities of liquid assets (cash), enabling it to release funds for more profitable lending. LIBOR rates are used to determine interest rates on many types of loan and credit products such as credit cards, adjustable rate mortgages and business loans.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
This is a mutual organisation owned by its members and not by shareholders. These societies offer a range of financial services but have historically concentrated on taking deposits from savers and lending the money to borrowers as mortgages, hence the name. In the mid-1990s many societies “demutualised” and became banks. One academic study (Heffernan, 2003) found demutualised societies’ pricing on deposits and mortgages was more favourable to shareholders than to customers, with the remaining mutual building societies offering consistently better rates. In 1900, there were 2,286 building societies in the UK; in 2011, there are just 51.
Also referred to as the bank rate or the minimum lending rate, the Bank of England base rate is the lowest rate the Bank uses to discount bills of exchange. This affects consumers as it is used by mainstream lenders and banks as the basis for calculating interest rates on mortgages, loans and savings.