Interest rates hit all-time low

6 January 2009

The Bank of England has cut interest rates to the lowest level seen in its 315-year history.

The central Bank's Monetary Policy Committee has voted to cut the official interest rate by 50 basis points to just 1.5%. This is the first time interest rates have fallen below 2% since the bank was founded in 1694.

The industry had largely expected a 100 basis point rediction this month.

The cuts means January is the fourth month in a row that the MPC has reduced the base rate; in October it cut rates by 0.5% to 4.5%, in November the MPC unveiled a surprise 1.5% cut to 3% and in December it voted to lower rates by 100 basis points to 2%.

Experts say that interest rates could fall to 0%. Back in December, America's Federal Reserve cut rates to a record low of between 0% and 0.25%, paving the way for similarly low rates in this country.

Bearish forecasting group Capital Economics believes that, in light of the deteriorating economic situation, the Bank of England will go the whole hog and reduce interest rates to zero. It predicts a 100 basis point reduction in February.

Vicky Redwood, UK economist at Capital Economics, says that although the MPC has noted the big reduction in the base rate over a short period (from 5% in October to 1.5% today), the rise in unemployment, contracting economic growth and fall in house prices all support the view that rates need to fall further.

But concerns remain that borrowers will not benefit from the cut.

Peter Rollings, managing director of estate agent Marsh & Parsons, says: “Never look a gift-horse in the mouth, but the vast majority homeowners will never feel the benefit of this cut. Banks simply aren’t passing these cuts on.

“The base rate cut is a further step in the right direction, but if we’re to see even a mild improvement in the number of people able to afford to move home – the government must start acting to thaw the mortgage freeze. Banks can’t lend because they have no money to lend – the government promised us action in November. The action we’ve seen to date is simply not enough.”

Andrew Montlake, partner at independent mortgage broker Cobalt Capital, says it is not clear whether banks will cut rates on new mortgages. However, he believes there could be opportunities in the fixed-rate mortgage market.

"I suspect we are very close to the limit at which lenders can profitably offer mortgages," Montlake explains "The products offered in the next few months could be the best we are likely to see in the current cycle. People who opt for a fixed-rate mortgage now could do very well, as interest rates will have to rise, perhaps as quickly as they have fallen, once we begin to exit the recession."

Other commentators are optimistic and believe January's cut could help slow house price falls.

Miles Shipside, commercial director at Rightmove, says: “We’re gettingto the stage where mortgage payments are becoming cheaper than renting.If this rate cut is passed on to borrowers, this could see house pricesbottoming out earlier than expected this year as consumer sentimenttowards buying will improve.”

Help for banks

As well as lowering rates further, Redwood believes more must be done by the government to re-start the mortgage market.

“There is little indication that the government’s recapitalisation of the banks is succeeding in getting them lending,” she says. “[…] the longer the government takes to introduce more measures, the bigger the damage to the economy from the credit crunch in the meantime.”

Recent reports suggest Gordon Brown and his chancellor Alistair Darling are considering another bank bail-out plan that will allow struggling firms to reduce their exposure to bad debts. However, Darling has stated that this was not the only, or most preferable, option on the table.

Paul Niven, head of asset allocation at F&C Investments, agrees that more government action is needed.

"With credit conditions only gradually improving, January's move - while welcome – is unlikely to provide much support to the shrinking UK economy," he says. "Over the coming months we expect to see further action to try and unfreeze credit markets. Quantitative easing, government guarantees on bank lending as well as further recapitalisation programmes will all be considered.

"While the end of the road in interest rate cuts is rapidly approaching there is more that policymakers can, and will, do to ease the length and depth of recession. As well as tackling the price and availability of credit, however, overall demand for credit will continue to diminish until there is greater clarity on stability in asset values and labour conditions. Such clarity remains some quarters away.”

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