Interest rate cut could make things worse

4 February 2009
The decision to cut interest rates by 0.5% in February is set to hurt savers – and could also damage the economy.

The Bank of England's Monetary Policy Committee has now cut the base rate for four months in a row, from 5% in October to just 1% today. The base rate is now at its lowest level in the Bank of England’s 300-year history.

However, February’s cut is controversial because of concerns that savers and pensioners have suffered enough in this low interest rate environment.

The fact that many banks are not passing cuts on to mortgage borrowers is also a cause for concern, and not everyone is convinced that lower rates will help the economy.

The National Institute of Economic and Social Research (NIESR), a think-tank, recently warned that lack of mortgage credit means further base rate cuts will be ineffective in helping the UK out of a recession.

And according to Dr Ros Altmann, a governor at the London School of Economics, the February rate cut could actually damage the economy rather than help it.

She believes that low rates undermine confidence and also pose a huge inflationary risk.

“Panic cuts are not the answer - they may give easy headlines for politicians desperate to 'do something' but they have gone beyond the point of being helpful,” Altmann warns.

“Such dramatic cuts undoubtedly undermine confidence and damage consumption. [And] it will be almost impossible to increase rates again in time to avoid a huge inflationary shock some time in the next two or three years.”

Savers versus borrowers

Meanwhile, Adrian Coles, director general of the Building Society Association, warns: “The cuts in interest rates have had a severe impact on savers. This drop in income is particularly serious for pensioners who have saved all their lives and now face a sharp reduction in their income and living standards.”

Interest rate cuts are designed to help borrowers and businesses. However, recent research by the Federation of Small Businesses (FSB) suggests that access to finance, rather than interest rates, is the biggest concern among many small businesses.

John Wright, national chairman at the FSB, says: “The concern now is that if rates are cut any further there may not be too much more room for manoeuvre in the economy.”

The Council of Mortgage Lenders (CML) has described any interest rate cuts as a “double-edged sword”, with some tracker rate borrowers benefiting but savers suffering.

Michael Coogan, director general of the CML, says: “Given that lenders need to attract savers to help fund new mortgage lending, this is an important factor in sustaining and improving the flow of lending.”

There is also a question mark over whether lower interest rates will increase confidence and activity in the housing market.

“The CML doubts that lower rates in isolation will reverse the low level of transactions or the downward pressure on house prices, especially at a time when the wider economy is in recession and consumers are anxious about their employment prospects,” explains Coogan.

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