The Bank of England has surprised virtually everyone today and slashed its base interest rate by 150 basis points (a basis point is 0.01%) to 3%, far further than most expected and by a full 1% more than their previous biggest 0.5% cut since being granted independence by Gordon Brown a decade ago. We now have the lowest base rate since the mid-1950s following a set of data releases this week on both the manufacturing and services sectors described by Gary Duncan in the Times as “crushingly poor”.
But the big question is – beyond providing a much needed morale boost for both consumers and businesses, can this help? Will borrowing costs fall for the wider population?
Obviously if you’re on a tracker rate mortgage that tracks the base rate, then yes, you’ll find your mortgage getting cheaper. But if you’re looking to remortgage, or you’re a small business that needs to roll a loan over any time soon, then the answer may not be so cut and dried. Why?
Banks borrow their money from the wholesale money markets (other institutions) and from depositors (savers). The Bank of England base rate has some impact (particularly for savers, who can probably expect to see their deposit rates slashed pretty rapidly). But the gap between the base rate and the banks’ actual cost of borrowing – measured by the sterling London Inter Bank Offered Rate, or LIBOR – is currently much higher than it was before the credit crunch.
So that’s one issue. But even if the cost of money was tracking the base rate precisely, you still wouldn’t see a return to the same sort of free and easy lending pre-summer 2007. That’s because – as the BBC’s Robert Peston pointed out earlier this week – the business of lending is becoming riskier.
For one thing, banks have belatedly realised that you can’t just give money to any one that comes in off the street. The credit crisis has been a nasty reminder that sometimes people don’t repay their loans, which can often result in the bankruptcy of the lender, unless they happen to have a stream of taxpayers’ money they can call upon.
But perhaps more importantly, lending is becoming riskier because we’re in a recession (not officially yet, but we’ll have confirmation soon enough). That means that the people and businesses you give money to are more likely to run into problems that prevent them from being able to repay the loans. So as well as being much more picky about who they give money to, lenders are also raising the profit margin they expect to make on each loan, in return for the rising risks involved in making it.
And the sad truth is the Bank of England appears to be realising far too late that UK plc is hitting the buffers hard and is now having to play catch up using its only available weapon – interest rate cuts. As broker Charles Stanley puts it “there is a growing feeling that the Bank of England has misjudged the severity of the recession and is therefore behind the curve”.
The Council of Mortgage Lenders certainly isn’t holding out much hope for borrowers. Earlier this week, reports The Times, it warned “that its members would not automatically pass a base rate reduction on to customers in the form of cheap loans.” The move “effectively gave the green light to its members” to disregard Chancellor Alistair Darling’s request that banks receiving government money should “maintain lending at 2007 levels.” Indeed just before the announcement Abbey National delivered a snub to the government by actually raising its tracker rates by 0.5%.
As Mr Peston points out, a more likely outcome for now is that most of the benefit from cuts in the Bank of England base rate will go straight to the banking sector’s bottom line, rather than cutting the debt costs of small businesses and individuals.
This shouldn’t come as a surprise. Just as consumers want to repair their balance sheets now – paying down debt rather than taking on more – so do the banks. After all, several of them would have gone bust by now were it not for government intervention. And the more profit they can make on the little new lending that they do, the faster their balance sheets can be repaired, and eventually (a long way off) they’ll feel comfortable enough to start lending again.
Of course, it’s somewhat galling that we’re paying through our taxes, and through lower savings rates, to prop up the banks. After all, even though inflation looks set to fall, it’s still sitting at an official rate of 5.2%. So after today’s cut, real (adjusted for inflation) interest rates are negative to the tune of 2.2%. Unless you can get a post-tax savings rate of above 5.2% – which will become harder after today’s cut – then you are effectively being punished for saving.
So, we might be bailing out the banks. But who’s there to bail us out?