The Bank of England has cut the base rate to a mere 1.5% - the lowest rate in its 315 year history. But some of the largest mortgage lenders are unlikely to pass on to borrowers the full benefit of the reduction.
Economy getting worse
Worsening economic conditions globally and in the UK were quoted by the Bank of England as the reason for the latest cut. According to the bank, "the world economy appears to be undergoing an unusually sharp and synchronised downturn." Its Monetary Policy Committee pointed to sharp falls in business and consumer confidence and the expectation that world trade growth in 2009 will be the weakest "for some considerable time".
In addition, there are fears that the UK inflation rate could plummet in the coming weeks. The main measure of inflation dropped to 4.1% in November, but continuing falls in energy and food prices, plus the impact of the temporary cut in VAT in the run-up to Christmas, are likely to trigger a much steeper cut in inflation, taking it below the Treasury's 2% target figure.
It is even possible that the recession may lead to deflation – with retail and manufacturing prices droping, leading to consumers and businesses deferring purchases in the hope that goods will continue to fall in price. The Bank of England said the latest 0.5% cut in base rate was necessary to put the UK on track for the 2% inflation target.
Not all mortgages will get cheaper
But some mortgage lenders are unlikely to pass on all of the latest cut in base rates to borrowers. Specifically, financial institutions are concerned that cutting interest rates on loans will force them to also cut savers' rates, further drying up the supply of funds for mortgage lending.
Michael Coogan, director general of the Council of Mortgage Lenders, explains: "This cut is a double-edged sword for retail-based lenders. While lower mortgage rates provide borrowers with the opportunity to repay their mortgage debt more quickly to reduce the term, lower savings rates impact lenders' ability to attract deposits and maintain the flow of mortgage lending in 2009.
"The market is still not functioning properly and is likely to lead to a fragmented approach by lenders, as they try to balance the interests of savers and borrowers and other pressures on their businesses, in responding to today's announcement."
Mixed response
There was a mixed initial response from mortgage lenders to the base rate cut. The Nationwide Building Society immediately announced that it was cutting its base mortgage rate from 4% to 3.5%, with effect from the beginning of February. It promised that any further Bank of England base rates would similarly be passed on in full to borrowers whose loans were set by its base mortgage rate.
HSBC – which is keen to expand its share of the mortgage market - was also quick to state that it would pass the cut on in full to mortgage borrowers, bringing down its standard variable rate from 4.44% to 3.94%. Tracker mortgages will also benefit in full. Lloyds TSB was another that rapidly stated that it would pass on the cut – and any further base rate cuts. The new standard variable rate for Lloyds TSB is 3.5%.
Halifax, though, is passing on only half the base rate cut to borrowers on its standard variable rate – which is being cut from 4.75% to 4.5%. It is passing on the full cut to customers with tracker mortgages, as is Abbey. But Abbey said that a decision on its standard variable rate – which is at present set at 4.94% - would be made "in due course".
Cuts may not help housing market
The Royal Institution of Chartered Surveyors warned that the cuts may do little to kick-start the housing market. Its chief economist Simon Rubinsohn says: "The decision to lower interest rates to just 1.5%, while welcome, is unlikely to provide any meaningful encouragement for banks to increase the availability of finance to either households or businesses. Indeed, the risk is that lenders are set to become even more restrictive over the coming months in the face of the worsening economic climate.
"With many first time-time buyers unable to find the finance to take an initial step onto the housing ladder and existing owner-occupiers needing to move similarly blighted, the time has come for the government to take direct action to restore an orderly property market."
Further cuts possible
There were conflicting signs about whether further base rate cuts are likely in future months. Paul Niven, head of asset allocation, at F&C Investments, says "the end of the road in interest rate cuts is rapidly approaching".
However, China has just cut its interest rates for the fourth time in 10 weeks, bringing them down by 1.08% to 5.58% - the lowest level since the Asian financial crisis in 1997. It also emerged from the minutes of the last rate setting meeting of the US Federal Reserve that it did not believe that even the cutting of rates down to their lowest level ever – between zero and a quarter of a per cent – would do much to avert the scale of the recession. Meanwhile there is speculation that the European Central Bank will cut rates as the eurozone economy also weakens further.
Although the Bank of England's scope for further cuts is limited, the scale of the worsening downturn may persuade it that even lower interest rates are a necessity.