Bank of England cuts rates by 1.5%

5 November 2008

The Bank of England’s Monetary Policy Committee (MPC) has shocked the City with a surprise 1.5% cut in interest rates, taking it from 4.50% to 3%.

While the majority of analysts predicted a cut today, perhaps by as much as a full 1%, the decision to reduce rates by 1.5% was more than expected. Interest rates are now the lowest they have been since 1955.

Howard Archer, chief UK economist at Global Insight, says the move was a bold step by the MPC. "We had expected a 100 basis point cut to 3.50%, but the even larger cut to 3% is fully justified, given that the already weak economy has clearly suffered a serious relapse and is in grave danger of suffering a prolonged, deep recession."

Last month the MPC, along with other central banks across the globe, unveiled an emergency rate cut of 0.5% a day earlier than expected as official figures revealed the gloomy outlook for the economy.

Vicky Redwood, UK economist at Capital Economics, believed that there was a case to cut rates by a full 100 basis points.

And Chris Cummings, director general of the Association of Mortgage Intermediaries, echoed her call.

“While there has been significant activity to maintain our banking system, the actions have yet to work their way into the mortgage market,” he says. “As a start, we urge the Bank of England to cut interest rates by 1%.”

There are, however, concerns that consumers might not benefit from lower interest rates because banks will fail to pass them on. For example, around 50% of lenders failed to reduce their standard variable rates (SVR) by the full 0.5% last month. Rates on new mortgages also show no signs of falling despite lower interest rates.

But the Council of Mortgage Lenders (CML) says that lenders might not benefit themselves from rate cuts, as the real cost of funding is determined by inter-bank borrowing.

A spokesman for the CML says: “It does not make commercial sense to insist or expect that lenders automatically pass on cuts in base rate to borrowers unless and until the cut flows through to an equivalent reduction in their own funding costs."

The cost of borrowing from other banks is one of the biggest influences on mortgage rates. This cost can broadly be gauged by three-month Libor; in recent years this sat within a range of between 0.15% and 0.2% of the base rate but is now 1.2% above it because of the continuing credit crunch.

“A decision not to follow a base rate reduction does not imply that the lender is ‘profiteering’,” the CML adds.

Meanwhile, the latest house price figures from Halifax reveal that property is becoming increasingly affordable as a result of house price falls with the average earnings ratio falling below 5.0 for the first time since 2004.

Property values have dropped 13.7% since last year, with prices declining a further 2.2% in October.

However, the mortgage lender says that housing affordability is improving significantly.

Continuing property price falls mean that affordability is improving significantly. Martin Ellis, chief economist at Halifax, says: “We expect a further improvement in the ratio over the coming months. The long-term average is 4.0"

The bank also believes there are signs that housing market activity show signs of stabilising, with three months of static mortgages approvals. While under “normal” conditions mortgage lending would be expected to increase month-on-month, the fact that things are not getting worse is a positive sign, says Ellis.


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