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housing market's 1.5% boost

A dramatic 1.5% cut in the base rate has underlined the level of problems in the property and financial markets. The scale of the Bank of England's rate cut caught analysts by surprise, with the base rate now falling to 3% - the lowest level since 1955.

housing market's 1.5% boostLenders' reluctance

Lloyds TSB, its specialist mortgage lending subsidiary Cheltenham & Gloucester and Abbey immediately cut mortgage lending standard variable rates in line with the Bank of England reduction. However, other lenders did not quickly follow suit - arguing that inter-bank lending rates (the Libor) are not falling in line with base rates.

Brokers suggested many mortgage lenders would absorb some of the cut to improve their own lending margins, rather than follow the lead of Lloyds TSB and Abbey. Darren Cook, an analyst at information providers Moneyfacts, said: "Mortgage holders currently paying their lender's SVR are hoping that their lenders will be as bold, but time will tell. Some lenders have still not passed on the bank's previous cut of 0.5% and if this is an indication of things to come, a decision to cut rates by 1.5% will indeed cause some healthy debate in bank and building society boardrooms up and down the UK."

Historic step

Ray Boulger of mortgage brokers John Charcol also expressed doubt about whether most borrowers will obtain the full benefits of the rate cut. "As with last month, I expect only a small minority of lenders to cut their SVR by the full amount," he said.

What is more, warned Boulger, even borrowers with tracker rate mortgages will not obtain the full gain if there are further bank rate cuts. "With some collars operating when the bank rate falls below 3%, the next cut in bank rate will mean that some borrowers with tracker mortgages will not see the benefit of further cuts," he explained. Boulger added that some tracker deals issued by smaller building societies have collars that mean this latest cut may also not be passed on to a minority of borrowers.

But Boulger stressed the historical significance of the Bank of England's decision. He said that ignoring the immediate response to sterling's withdrawal from the Exchange Rate Mechanism in 1992, "this is not only the biggest cut ever implemented by the [Bank of England's] MPC, but also the largest reduction since the 2% fall in March 1981 from 14% to 12%." But, proportionately, the latest cut is much more significant, he argued, as it potentially cut borrowing costs by a third.

More bad news?

The financial markets have interpreted the size of the base rate cut as meaning that the Bank of England knows that more bad economic news is on the way.

It followed just a day after the UK's largest mortgage lender, the Halifax, announced that average house prices have fallen by 15% in the last year. This means that the average house is worth £30,000 less than it was 12 months ago.

But with the decline in house prices, properties have now reached improved levels of affordability. Martin Ellis, Halifax's chief economist, said: "House prices declined by 2.2% in October. Housing market conditions remain challenging in the face of the significant pressures on householders' incomes and the reduction in the availability of mortgage finance since last summer. But housing affordability is improving significantly. The house price to average earnings ratio has fallen below 5.0 for the first time for four and a half years. We expect a further improvement in the ratio over the coming months."

Helping borrowers

The Council for Mortgage Lenders responded positively to the Bank of England's move, but also hinted at doubts about the extent to which borrowers would benefit. CML director general, Michael Coogan, said: "This is a strong and decisive move by the Bank of England. They have grasped the nettle in a worsening recession environment. What is important is how this feeds through to lenders’ borrowing costs - and lenders will need to balance the interests of savers, as well - but such a sharp downward movement provides more room for lower borrowing costs more quickly."

The Building Societies Association said that lenders might have difficulty in passing on the full benefits of the rate cut for a variety of reasons, not just the failure of the inter-bank lending rates to fall in line with base rates. It said that building societies also needed to respond to upward competitive pressures on savings rates, the need to maintain margins and the obligation to make additional payments to the Financial Services Compensation Scheme to bail out Bradford & Bingley and the Icelandic banks.

The Bank of England indicated that one of the factors influencing its decision to cut the base rate was the fact that "residential investment has fallen sharply".

  • by Paul Gosling