Bank of England cuts interest rates to 5%

10 April 2008

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."

Economic uncertainty

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."

Find your way through the credit crunch mortgage maze.

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