Interest Rate ReliefPosted on: 11 April 2008 by Gareth Hargreaves
Mortgage holders may get some respite as the Bank of England reduces the interest rate to 5 per cent.
The Bank of England's Monetary Policy Committee voted to reduce the official Bank Rate paid on commercial bank reserves by 0.25 percentage points to 5.0% on 10th April 2008, after no change in March.
CPI inflation rose to 2.5% in February. The Bank expects inflation to rise further this year, reflecting the continuing impact of higher energy and food prices, as well as the recent depreciation of sterling on import costs.
"The MPC has offered a small ray of hope to the turbulent mortgage market," says Ann Robinson, Director of Consumer Policy at uSwitch.com. "The decision to cut the base rate by 0.25% to 5% will come as welcome news for the nation's struggling borrowers - if this cut is passed on in full then homeowners with a £150,000 repayment mortgage will find themselves £22 a month or £264 a year better off."
The rate cut shows that the Monetary Policy Committee recognises the potential risks to economic growth and the housing market, according to Adrian Coles, Director-General of the Building Societies Association.
"With activity in the housing market cooling, this rate cut should make it easier for borrowers to meet their mortgage costs. The cut will be particularly welcomed by those taking out a new mortgage and those coming off a fixed rate product. However, the MPC's rate decision may not be reflected by changes to the money market rates. Therefore the quarter point reduction will not necessarily be reflected in the fixed rates on offer straight away."
Even if commodity prices remain at their current high levels, inflation should fall back. But to ensure that inflation meets the 2% target in the medium term, the Bank of England says it needs to balance two risks. On the upside, above-target inflation this year could raise inflation expectations so that in a slack economy inflation would remain above the target. On the downside, the disruption in financial markets could lead to a slowdown in the economy that was sufficiently sharp to pull inflation below the target.
In the Bank's judgement, the balance of these risks to the inflation outlook in the medium term justifies a cut in Bank Rate this month. Credit conditions have tightened and the availability of credit appears to be worsening. While recent depreciation in sterling will support exports, prospects for output growth abroad have deteriorated. In the UK, business surveys suggest that growth has begun to moderate and that a margin of spare capacity will emerge during this year. This should help to keep inflationary pressures in check in the medium term.
Against that background, the Bank judged that a reduction in Bank Rate of 0.25 percentage points to 5.0% was necessary to meet the 2% target for CPI inflation in the medium term.
However, this is a drop in the ocean for the average consumer's monthly budget, according to Robinson. "In the last year alone people have been hit with an inflation-busting 9% or £1,783 increase to the cost of essential bills compared with a miserly 3.4% or £533 increase to the average wage. Overall, this leaves the nation's households £21 billion in the red. Against this backdrop, £22 a month seems like a modest saving, but it could be a lifeline for those families struggling to stay afloat.
"While the base rate reduction provides light relief for some, first time buyers and those set to come off a fixed rate mortgage, could be forgiven for not performing cartwheels at the news. Many lenders are yet to pass on the recent base rate reductions - instead they are busy increasing rates, demanding larger deposits, tightening lending criteria and, in some cases, withdrawing deals from the market altogether.
"By refusing to pass on rate reductions and taking extreme measures to reduce business volumes, lenders are fuelling the current lack of confidence in the property market. Sadly, there is no sign of the situation improving with the Libor rate (London Interbank Offered Rate) reaching around 6% this week, 1% higher than the new base rate. This means that mortgage providers are paying a premium to get hold of cash to lend, so they really have their hands tied until the wider economic climate warms up."
Robinson advises, "While all this is going on it's very easy for consumers to feel helpless. But, in fact, we can all help ourselves by taking a good look at our household budgets to see where we can cut costs. There are potential savings of around £3,000 to be made on household bills and financial services - all it takes is some careful shopping around."
There are significant differences between today's economy and that of the last housing downturn in 1988 - 1995, according to Ray Boulger of John Charcol. "I don't expect the scale or duration of current house price weakness to be on the same scale," he says.
"Confidence is the most important factor influencing house prices and the two most important factors influencing confidence are interest rates and the level of unemployment. Capital Economics is now forecasting GDP growth next year will fall to only 1% and although unemployment has so far remained low, it will increase in a slowing economy, but not on the same scale as the early 90s increase.
"As far as interest rates are concerned today we, or at least the MPC, have control of our own destiny, whereas the last Government's highly dubious decision to join the Exchange Rate Mechanism left sterling such a hostage to fortune that Bank Rate remained far too high for much too long and crucified the economy as a result."
On the savings side, Coles says, "Building societies have received record saving deposits in recent months, and savers are likely to continue to be attracted by the competitive rates offered by building societies as well as the lower risk to their savings compared to investing in shares."
He offers the advice, "In the current uncertain economic climate, it is important that homeowners ensure that they will be able to maintain mortgage repayments and that they contact their lender as soon as possible if they foresee any repayment problems."
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