Base rates have been cut to a new all-time low of a mere half a per cent, the Bank of England has announced. Underlining the weakness of the economy, the Bank also confirmed expectations that it is to increase money supply through an unfunded £75bn asset purchase programme.
Deflation fear
The Bank of England's Monetary Policy Committee (MPC) explained that halving the previous 1% base rate was necessary as part of its attempt to steer the UK economy towards its target of a 2% inflation rate. Without the cut and the money supply increase, the Bank fears the economy will become deflationary, creating a vicious circle of deferred spending as consumers and businesses wait for prices to fall further.
It is also hoped that the base rate cut and Asset Purchase Facility will lower the cost and increase the supply of lending. But it is unclear what impact the asset purchase programme will have.
The Asset Purchase Facility is the first application in the UK in modern times of what economists call 'quantitative easing' - improving the state of the economy by increasing the money supply. It has been termed 'printing money' in many newspapers, but this is a misnomer as there will not be an increase in the supply of notes and coins in circulation.
Buying bonds
Instead, over the next three months the Bank of England will buy government and corporate bonds from banks. In theory, this should allow those banks to make more loans to other banks, businesses, consumers and homebuyers. The problem is that with many banks still fearing they may have to declare higher levels of losses and face up to as yet undeclared liabilities, the result might simply be that banks hoard the extra money as increased reserves.
Uncertainty over whether the strategy will work was stressed by Stephen Gifford, chief economist at accountancy firm Grant Thornton. "The process of quantitative easing is not the all out solution that many commentators have presumed," he says. "It is a high risk strategy riddled with economic, political and practical problems. Few policy makers have any experience of implementing it and how much easing is appropriate is largely guess work."
But, says Gifford, there was no real alternative for the Bank of England with retail banks still not lending sufficiently.
Bad news for savers
Interest rate cuts are bad news for savers - and this has repercussions on the availability of funds to lend. Michael Coogan, director general of the Council of Mortgage Lenders, says: "This latest cut presents immense challenges for lenders whose margins are already squeezed as a result of previous reductions, leaving little scope to lower discretionary mortgage rates further. Savings are the lifeblood of mortgage lending and unless lenders can offer competitive rates to savers their ability to offer new mortgages is restricted."
Coogan adds that the Government's own National Savings and Investments has reported record high levels of savings deposits. This is at the expense of savings with banks and building societies, depriving them of the means to improve mortgage lending. So far from being good news, the latest interest rate cut will further deplete mortgage lenders' funds and "represents a double whammy for prospective mortgage borrowers", he says.
'A kick in the teeth'
The point was reinforced by the Building Societies Association, some of whose members have stopped passing on rate cuts on the grounds that they need to do more to attract savers and build up a supply of money to lend for homebuying. Adrian Coles, Director-General of the BSA, describes the MPC decision as "a kick in the teeth for savers".
Coles argues: "It will be felt hardest by the many elderly people who have saved responsibly all their lives and are reliant on their savings interest to maintain an acceptable standard of living in retirement. It will also harm the aspirations of the many people who are finding it difficult to get a mortgage, particularly first-time buyers with relatively small deposits. Lower interest rates reduce the incentive to save and, in turn, this limits the flow of funds into the mortgage market."
The good news
But the BSA welcomed the Asset Purchase Facility as a potentially important means of improving the availability of money. A similar response came from the Association of Mortgage Intermediaries.
AMI director, Robert Sinclair, says: "The £75bn injection..... should begin to go some way to alleviate" the lack of money available for mortgage lending. He adds: "It is encouraging that the Bank [of England] is finally recognising the key issues facing markets and the systemic problems preventing lenders, intermediaries and consumers from moving forward." But Sinclair is urging the Government to speed up moves to remove 'bad loans' from banks' books to enable them to make money more readily available for new lending.
No panacea
The Royal Institution of Chartered Surveyors also believes the move to increase money supply is helpful. Its chief economist Simon Rubinsohn says: "Although this is no panacea, it should over time begin to help boost confidence and support private sector spending." But he warns that there will be a delay before the moves translate into any effect on the housing market. He says: "house prices look likely to fall further in the near term even though there are some signs that transaction levels may now be bottoming out".
Yolande Barnes, head of residential research at mortgage brokers Savills, is also sceptical. "The mainstream housing market will be, at best, indifferent to the interest rate cut," she says. "We have been saying for months now that it is not the cost of credit, but the lack of it that is damaging the housing market."
Several lenders quickly responded by cutting their lending rates. Nationwide will cut its SVR by 0.5%, to 2.5%, from 1st April; Halifax is also making the full half per cent cut, bringing its SVR down to 3.5%; while Abbey is passing on 0.45%, reducing its SVR to 4.24%.