Rate cut reaction

Posted by Jaimie Kanwar on Friday, February 09, 2001

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Economic viewpoint
Rate cut reaction

For many people, midday on Thursday is a period of the week when the attention turns to food. However, this week was slightly different, as the lunchtime news brought a tasty morsel of economic information for the nation to digest.

Finally, for the first time in the best part of two years, homeowners can look forward to lower mortgage payments, after the Bank of England cut the base rate by a quarter-point to 5.75 per cent. However, not everyone was as pleased as they might have been and there isn't quite universal agreement about what the future holds.

The factors that led to the decision have been discussed at length in our news section over the past month, so we're not going to repeat them in much detail here. Briefly:

The US economy is on the brink of recession, despite the Federal Reserve slashing a whole point of interest rates in January to head off the recession threat. America is such a major world economic force, that economists are increasingly worried about the effect that a recession there would have on the global economy. Japan has just cut its interest rates and the UK domestic economy is slowing, though not as quickly as in the US.
Inflation is another concern for the bank. They have a government-set target of 2.5 percent, but inflation has been running at well below that level for nearly two years. Whilst it is better to be slightly under this mark than slightly over it, a benign retail price outlook is causing concern that inflation could fall further.
Meanwhile the recovery of the manufacturing sector has slowed down again, after fourth quarter gross domestic product figures for Britain were weaker than expected, showing an annual growth rate of just 2.4 percent.

The best thing about the MPC decision, as far as most people are concerned, is the fact that it will ultimately mean lower monthly outgoings on mortgage repayments. As long as the banks and building societies do the decent thing and pass on the savings from the rate cut to the consumer, everyone should benefit from more money in their pocket at the end of the month.

Some lenders reacted to the decision by announcing cuts to their rates within minutes. Halifax, Virgin One, HSBC, Northern Rock and Abbey National are amongst those who made immediate decisions. Most of the others are expected to follow suit in the near future. Some, like the Nationwide, tried to steal a march on the competition by lowering rates in December. The Nationwide has already announced that it is reviewing its position and may make a further cut.

If passed on in full, homeowners with a 25-year £50,000 repayment mortgage will typically see their monthly bill fall by just over £8. The savings rise more or less in line with the level of borrowing - a £100,000 borrower will pay £16 less and £24 less on a loan of £150,000.

Not everyone will benefit immediately. Many mortgages will not be affected by the change in rate until the end of a monthly, quarterly or even yearly period. I for one have a mortgage which will not adjust to the new level until September of this year.

New borrowers may be advised to wait a week or so before finalising their choice of mortgage, to see where the dust settles and who does and doesn't cut their rate. Existing borrowers should check with their lender to see what their own situation is. One area where everyone will lose out is in the corresponding reduction in savings rates. It shouldn't affect current accounts too much. It would be quite difficult for them to pay significantly less interest, as some of them pay next to nothing as it is!

However savings rates are likely to come down by at least as much as the financial institutions reduce their mortgage rates. Keep your eyes peeled for quiet announcements...

There has been widespread relief from business leaders, economists and other interested parties that the MPC did not 'bottle' the decision and fail to follow the US reduction. The rate cut will help confidence in the manufacturing by helping to reduce Stirling against the Euro and there boost exports.

Here are what some of the people who were quite pleased had to say on the matter:

Ian Fletcher, chief economist at the British Chambers of Commerce, said: "It's been a long time coming, but this decision will help reassure businesses and investors at a time of growing economic uncertainty.This rate cut will help protect against the knock-on effects of weaker global demand on our economy."

Kate Barker, chief economist at the Confederation of British Industry, said: 'This cut has come at the right time. Firms are finding the economic tea-leaves harder than usual to read. Companies needed this cut to bolster their confidence and to sustain investment, which is vital to the UK's long-term future.'

Stephen Radley of the Engineering Employers' Federation said: "The MPC's move will give a much needed boost to growth, confidence and investment."

However, some people did not feel that the MPC had done enough, and insisted that further rate cuts were necessary:

Roger Lyons, general secretary of the Manufacturing Science and Finance union said: "A quarter of a teaspoon of medicine is not enough to cure the ills of UK manufacturing. It's the right medicine, it's just not enough."

There is nothing quite like the aftermath of a decision to encourage people to get their crystal ball out and predict how things will be affected. Apart, of course, from the run up to a decision, at which point we all become experts with the correct opinion.

However, apart from one or two notables who are staying loyal to the view that rates will have to rise again, most observers are now agreed that rates will fall further this year. The financial markets are certainly indicating that this is where the smart money is, however, opinion is divided about how quickly this will happen.

For instance, John Monks, general secretary of the TUC, said: "With inflation still well below target, the Bank has no reason not to cut again, and soon."

But the consensus view, which we would have to agree with, is that the status quo will be maintained until after any General election, unless something drastic happens to the domestic or global economy.

Ray Boulger of Charcol said: 'We expect rates to fall further but the question is when. With the budget in March and the general election earmarked for early May, borrowers may face a three month delay before benefiting from a further rate cut.'

Ninety-five percent of respondents in a Reuters survey thought that the MPC will pause to see how much the U.S. economic slowdown affects Britain and perhaps await the outcome of a possible general election, but then lower rates again in the second quarter, with rates then likely to stay at 5.5 percent until the end of the year.