Interest rate cut to just 0.5%
The Bank of England has revealed another base rate cut, with the official rate of interest reduced to a new low of just 0.5%.
It has also been given the green light by the Treasury to use quantitative easing, or creating more money. In a statement, the Bank of England said that the low base rate by itself still leaves a "substantial risk" of the UK entering a period of deflation.
It has therefore decided use quantitative easing, with the aim of boosting the supply of money to banks, lowering the cost of borrowing and raising the rate of spending. The central bank will, therefore, pump £75 billion into the markets.
The cut was largely anticipated by economists. The central bank’s Monetary Policy Committee (MPC) has cut the base rate for six consecutive months, falling from 5% in October to just half a percentage point in March. The minutes from its February meeting made it clear that the MPC believes lower interest rates are essential for economic recovery.
Rate cuts are designed to help lower the cost of borrowing for both households and business. However, the effectiveness of this monetary policy is under doubt; apart from concerns that only tracker mortgage borrowers are benefiting from rate cuts, and warnings that prudent savers are being the most severely punished, the economy continues to contract and the recession shows no sign of abating.
Adrian Coles, director general of the Building Society Association, says lower savings rates will reduce the inflow of money people put in institutions – as a result, banks and building societies will be forced to further cut back their lending operations.
"The rate cut is a kick in the teeth for savers who will see their already diminished interest payments fall even further," he says. “It will also harm the aspirations of the many people who are finding it difficult to get a mortgage, particularly first-time buyers with relatively small deposits. Lower interest rates reduce the incentive to save, and in turn, this limits the flow of funds into the mortgage market."
According to uSwitch.com, the latest base rate cut will bring the average savings rate down to just 0.58% - offering a miserly return of £16.32 a year on the average savings balance of £2,813.
Coles adds: “We do, however, welcome the central bank's announcement to implement quantitative easing and we share the government’s hope that this will increase the flow of money in the economy and lessen the severity of the downturn.”
Lower interest rates encourage people to spend, not save. But when interest rates can go no lower and there is a sharp drop in consumer and business spending, a central bank’s only option to stimulate demand is to pump money into the economy directly. This is quantitative easing. The Bank of England purchases assets (usually government bonds, or gilts) from private sector businesses such as insurance companies, banks and pension funds financed by new money the Bank creates electronically (it doesn’t physically print the banknotes). The sellers use the money to switch into other assets, such as shares or corporate bonds or else use it to lend to consumers and businesses, which pushes up demand and stimulates the economy.
With a tracker mortgage, the interest you pay is an agreed percentage above the Bank of England’s base rate. As the base rate rises and falls, your tracker will track these changes, and so rise and fall accordingly. If your tracker mortgage is Bank of England base rate +1% and the base rate is 5.75%, you will be paying 6.75%. Tracker rates are lower than lender’s standard variable rate (SVR) and as they are simple products for lenders to design, they usually come with lower fees than other mortgage schemes.
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.
This is the opposite of inflation and refers to a decrease in the price of goods, services and raw materials. Economically, deflation is bad news: the only major period of deflation happened in the 1920s and 1930s in the Great Depression. Not to be confused with disinflation, which is a slowing down in the rate of price increases. When governments raise interest rates to reduce inflation this is often (wrongly) described as deflationary but is really an attempt to introduce an element of disinflation.
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.