Interest rates stick

Posted on: 17 January 2008 by Gareth Hargreaves

What the Bank of England's rate hold means for mortgages and the economy.

In light of a slowing economy and the prospect of inflation, the Bank of England has decided to maintain the base rate at 5.5 per cent.

The Bank's Monetary Policy Committee (MPC) vote on 10th January 2008 comes after a change on 6th December 2007 in the official Bank Rate paid on commercial bank reserves, a decrease of 0.25 percentage points to the current 5.5 per cent.

The decision is not wholly unexpected, although the market would not have been surprised if they had cut rates, according to Ian Kernohan, Economist at RLAM. He expects a cut next month, as the MPC seeks to head off the risk of a recession. Several major retailers including Marks & Spencer have announced poor results post-Christmas.

Although borrowers may have been eager for a rate cut, Jenny Challenor, Mortgage Strategist at Torquil Clark, welcomes the news that the Bank of England has not given into untimely pressure to cut interest rates.

"A 0.25% cut from 5.5% to 5.25% would have reduced a £100,000 tracker repayment mortgage from £614.09 to £599.25 a month, a saving of £14.84. Yes it would have relieved the pressure of borrowers mentally, but not made sweeping differences to repayments on the average loan.

"Right now, borrowers need to clearly understand the message, that we are not yet out of murky financial waters. This would have been the wrong time to lull those who are financial strained into a false sense of security. Christmas overspending must be paid back as a priority, January sales should not be indulged unless you can afford to do so and those who are struggling now, need more than ever, to get their finances in order."

Borrowers on tracker deals are going to be disappointed, as Challenor points out, but tracker mortgages are the most attractive proposition in 2008, claims Andrew Montlake, partner with independent mortgage broker Cobalt Capital. The precarious state of the housing market, coupled with ongoing fall-out from the credit crunch, means rates are still likely to come down two or three times during 2008, even though they were kept on hold this month.

"If your mortgage is tracking the Bank of England base rate, you will instantly be onto a winner," says Montlake. "Given that it will be some time before fixed rate products become competitive again, and that lenders, in the current market, are unlikely to pass on rate reductions in full to those on SVRs (Standard Variable Rate), the clever money is very much on tracker products."

A tracker mortgage is a good option for homeowners who are financially flexible and looking to take advantage of any further interest rate cuts during the next 12 months, advises Stephen Leonard, Director of Mortgages at Alliance & Leicester, although first time buyers looking for a mortgage deal should consider taking out a fixed-rate mortgage which will give them the security of fixed monthly payments.

While tracker rates are looking a little more affordable than fixed rates from most lenders, Nici Audhlam-Gardiner, Head of Abbey Mortgages warns that the decision to take out a tracker should only be made if borrowers are confident that they could withstand a further increase in rates, which is not out of the question over the next two years.

"There are some excellent fixed rate deals to be had in the market, and these are likely to continue to be the preferred option for more cautious borrowers until a downward trend in base rate is seen. Borrowers are still feeling stretched after the rate increases from the last couple of years, and those coming to the end of their fixed rate deals are still likely to see their interest rates go up.

"While we've seen indications of house price growth in December, this came after a couple of months of house price falls and a drop off in activity from house buyers and sellers. A rate cut is still looking probable in February, if the underlying market conditions don't improve."

Overall financial conditions have eased substantially over the last month, explains Richard Dingwall-Smith, Chief Economist, Scottish Widows Investment Partnership (SWIP), as a result of a significant reduction in the strength of the pound sterling and a fall in inter-bank interest rates. At the same time there are still some significant inflation worries, particularly relating to energy prices which now look likely to keep inflation above 2 per cent throughout this year.

"Nonetheless, we continue to expect two quarter point cuts in Bank Rate over the next few months, most probably in February and May, which would take it down to 5.0 per cent."

Dingwall-Smith says such a move is likely to be justified by a clear slowing of the UK economy against the background of a weaker housing market, subdued consumer spending, and decelerating economic growth in the US and continental Europe.

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