Brexit could force interest rates even lower
The Bank of England could be forced to cut its 0.5% base rate even further if Britain votes to leave the EU, according to claims in one newspaper.
The Sunday Times reports that the Bank of England has been in “informal discussions” with bank chief executives to gauge whether they are strong enough to stomach another rate cut.
For several years, an interest rate rise has been looming on the horizon, but underwhelming figures on the UK economy, which grew 0.4% in the first quarter of 2016, combined with low inflation, means a rate cut now seems more likely than a hike.
“The change in sentiment from the Governor of the Bank of England highlights how quickly the change in outlook for the UK and indeed global economy has come about,” says Adrian Lowcock, head of investing at AXA Wealth.
“However, it is difficult to see any decision being made ahead of the EU Referendum vote on 23 June. Whatever the result is, Mark Carney is likely to want to see what the effects on the UK economy actually are. He will also have an eye on the actions of other central banks, particularly the Bank of Japan and the Federal Reserve.
“Inflation has remained stubbornly low even though many of the preconditions, such as low unemployment, for its return do exist.
“As such, it looks as though interest rates will remain at low levels for the foreseeable future and the search for income will remain a priority for some time. Investors and savers will need to be proactive in their hunt for yield.”
Last month Mr Carney warned that a Brexit could damage the British economy in the short term, and Chancellor George Osborne warned a vote to leave could lead to higher mortgage costs.
What would negative interest rates mean for your money?
Rates don’t have far to drop from the current 0.5% before they turn negative. That would be unchartered water for the UK, though Sweden, Japan and Switzerland are all currently operating with negative interest rates.
Another rate cut would be terrible news for savers, who have seen interest on their savings steadily eroded over the last few years (see the table below), even though our base rate hasn’t changed for 86 months.
Source: Bank of England.
Generally, savings rates go up and down with the base rate, but this relationship has been distorted by cheap money offered to banks through the funding for lending scheme, meaning they don’t need to offer competitive rates to win your savings.
According to Moneyfacts, the average savings account has delivered 16% returns over the last decade. But as prices have increased 26% over the same period, these savings accounts have lost money in real terms. See our weekly guide to the best savings accounts.
While lower interest rates don’t help savers, it’s not clear whether they would help borrowers either. Mortgages are remarkably cheap by historical standards and it’s not clear whether they could fall much further. Paradoxically, a rate cut could lead to higher borrowing costs as banks’ profit margins are squeezed.
David Hollingworth, mortgage expert at London and County Mortgages says: “If base rate was to fall those with tracker rates could enjoy a fall in their rate, assuming that the deal is not collared at a certain level.
“However there is an argument that new borrowers could start to see mortgage rates climb. If base rate were to fall there may be only so far that banks can cut savings rates which are already on their knees. That could mean that mortgage rates don't fall further or even climb as banks attempt to preserve their margin.”
Last month, figures from Swiss investment bank UBS suggested that since Switzerland cut its base rate below zero, mortgage costs have risen as Swiss banks attempt to keep paying interest on savings accounts.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
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).
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.