Rate cut will hurt savers and borrowers

Rate cut

The Bank of England has cut the base rate to just 0.5% in March, a move that experts warn will hurt both savers and borrowers.

 The central bank’s Monetary Policy Committee has voted for six consecutive monthly base rate cut since October, and the rate is now at an all-time low. Rate cuts are designed to help lower the cost of borrowing for both households and business, thus kick-starting the economy.

 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.

 In addition, the base rate cannot turn negative and with it edging ever closer to 0%, there is only so much more monetary policy can achieve. As a result, the chancellor Alistair Darling is expected to give the Bank of England permission to introduce quantitative easing – commonly known as printing more money – immediately after the base rate cut.

Impact of base rate cut

While borrowers with loans that track the Bank of England base rate will be celebrating the latest cut, experts warn many more people will suffer as a result.

The Building Societies Association (BSA), a trade body representing the 55 building societies in the UK, says the cut is bad news for savers and most borrowers.

Adrian Coles, director general of the BSA, 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. 

“We need to encourage an increase in the flow of funds into the mortgage market, not take steps that would further restrict that flow,” says Coles. 

According to David Hollingworth, mortgage expert at London & Country, the fact that lenders continue to reserve the best rates for people with big deposits or equity stakes is still the major issue affecting borrowers.

“There hasn’t been a radical change in the mortgage market for a year, and people with small deposits continue to face higher mortgage costs,” he explains. “I doubt that rates on new tracker deals will get any cheaper.”

Although tracker mortgages have increased in popularity as a result of the low base rate, Hollingworth believes that fixed-deals will now receive more attention from consumers.

“The base rate can’t get much lower and people are starting to realise that it will have to go up again – possibly very quickly – in the future,” he says.

In a rising base rate environment, fixing may look like an attractive propositio. But because lenders still lack an appetite for lending, they may increase interest rates or fees, or introduce tougher criteria, as a result.

Two new mortgage deals could offer an alternative. “Both Coventry Building Society and Woolwich have introduced tracker mortgages with price caps – this means that borrowers can benefit from any further base rate cuts but also be protected when rates start to rise again,” says Hollingworth.

For savers, meanwhile, the outlook continues to look bleak. According to uSwitch.com, 41 savings providers cut their rates by as much as 1% in the first four days of March alone. As a result, the average variable savings rate is now just 1.08% AER.

The price comparison website warns that the 0.5% base rate cut in March would 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.

Such miserable returns, along with stretched budgets, has already prompted people to dip into their savings – banks report that savers withdrew £2.3 billion from their nest-eggs in January, the first monthly fall in retail deposits since July last year and the largest amount since records began more than a decade ago.

James Caldwell, director at Fairinvestment.co.uk, also warns that the cut will do little to help the economy. 

"The latest interest rate cut is just another attempt at reassuring consumers and businesses that the Bank of England is doing something to combat the recession," he explains.

He calls for the central bank to announce quantitative easing measures, which he believes will put more cash into the economy and should have a positive impact on money markets.

"It is clear that more needs to be done to help consumers and small businesses, and only time will tell if quantitative easing will have the desired effect," Caldwell adds.