Interest rate held for second month
The Bank of England has voted to hold the official interest rate at 0.5% for May, following a similar freeze in April.
The central bank has also pledged to continue with its quantitative easing measures, where it creates more money. It will increase this scheme by £50 billion to £125 billion. It expects it will take another three months to complete this programme, with the amount of money creation kept "under review”.
In a statement, the Bank of England says the world economy remains in “deep recession” with the banking and financial system remaining fragile.
Despite the fall in inflation in March, to 2.9%, this remains “significantly higher” than the 2% inflation target. The central bank says the Consumer Prices Index (CPI) – the official measure of the cost of living – will continue to drop and will fall below the 2% later this year.
It predicts measures such as quantitative easing will lead to “a recovery in economic growth, bringing inflation back towards the 2% target”.
However, it admits the timing of that recovery is “highly uncertain”.
“In the light of that outlook and in order to keep CPI inflation on track to meet the 2% inflation target over the medium term, the MPC judged that maintaining base rate at 0.5% was appropriate,” the central bank said in its statement.
Impact on consumers
The low base rate is bad news for savers, as interest rates on accounts have fallen as well.
James Caldwel, director of Fairinvestment.co.uk, says pensioners are the worst hit.
"This time last year, pensioners were enjoying interest rates on their savings that were 10 times what they are now, when the base interest rate stood at 5% - now the average no notice savings account has a rate of just 0.65%," he adds.
However, for homeowners with mortgages that track the base rate, the news will probably be well received.
But Andrew Montlake, director of independent mortgage broker Coreco, is concerned that when the base rate does start to go up again (as it inevitably will) these borrowers will get a shock.
"There is growing concern that inflationary pressures will ignite a series of sharp rate hikes later this year and on into 2010," he explains.
"With house prices still likely to be low when rates do start to rise, many homeowners will be at the mercy of higher interest rates without being able to remortgage because of insufficient, or negative, equity."
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.
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.
The Consumer Price Index is the official measure of inflation adopted by the government to set its target. When commentators refer to changes in inflation, they’re actually referring to the CPI. In the June 2010 Budget, Chancellor announced the government’s intention to also use the CPI for the price indexation of benefits, tax credits and public sector pensions from April 2011. (See also Retail Prices Index).
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.
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).