Bleak warning as rates cut to 1 per cent

The Bank of England's drastic action came on another day of worrying news about the state of the economy

The Bank of England cut interest rates to a new record low of 1 per cent yesterday, warning that "the global economy is in the throes of a severe and synchronised downturn".

The Bank's Monetary Policy Committee brought rates down by half a percentage point from the level set in January. It has now cut rates for five successive months, the most dramatic decline in the cost of borrowing in the Bank's 315-year history: this time last year, the bank rate stood at 5.5 per cent.

Comparatively little immediate effect will be felt by many businesses and households, as the semi-frozen credit markets continue to restrict lending. However, some mortgage customers will shortly see a cut in their monthly bills and, provided the money markets do ease over the coming months, other borrowers should also see some benefit. Lloyds, Halifax, Nationwide and Barclays, declared yesterday they will soon pass on the reduction in full for tracker mortgages and customers on standard variable rates.

In its gloomiest assessment yet of the prospects for the UK economy the MPC said: "In the United Kingdom, output dropped sharply in the fourth quarter of 2008 and business surveys point to a similar rate of decline in the early part of this year.

"Credit conditions faced by companies and households have tightened further. The underlying picture for consumer spending appears weak. Businesses have responded to the worsening outlook by running down inventories, cutting production, scaling back investment plans and shedding labour."

The dire condition of the economy was underlined yesterday with 850 fresh job losses announced by Ford and GlaxoSmithKline said it would also be cutting an unspecified number of posts in a restructuring programme. New car sales fell by 30 per cent during January, compared with the same month last year. The Halifax house price index showed that house prices actually rose by 1.9 per cent last month, though most economists dismissed that as a blip, and stuck to their firm belief that house prices will end the year about 10 per cent lower than they are today.

Next Wednesday, the Bank will publish its latest estimates for future inflation and growth in its quarterly inflation report. They are likely to be much more downbeat than either the November inflation report or the Treasury's official forecast, both of which suggested that the UK economy will shrink by about 1 per cent this year. Independent observers from the IMF to the National Institute for Economic and Social Research believe that the UK will contract by closer to 3 per cent over 2009 – the worst since the Second World War.

The Bank's move was in line with City expectations but some attacked the move. Adrian Coles, director general of the Building Societies Association, said: "The rate cut is an assault on savers who will have seen their interest payments drop by 83 per cent since July 2007.

"But the decision is also bad news for mortgage borrowers. Although the cut will benefit borrowers with tracker or variable rate mortgages, research by BSA has found that concern over getting a mortgage or getting a large enough mortgage is a much greater worry than affording mortgage repayments. People are less likely to save and the flow of funds into the mortgage market will be further disrupted."

What it means... for savers

Unless your money is stashed in a fixed-rate savings account, the chances are that yesterday's Bank of England rate cut will lead to yet another fall in your earnings from personal savings. For people who live off that interest, the recent round of sudden and sharp rate cuts has been devastating.

But while the average account now pays less than 1 per cent, there is no need to accept such a miserly rate. Many accounts still pay more than 4 per cent.

The best rates are available to those willing to tie up their money up for at least a year. ICICI, for example, is paying a rate of 4.3 per cent on its one-year savings accounts, while FirstSave, owned by First Bank of Nigeria, is offering 4.25 per cent. Deposits in both of these banks are 100 per cent covered by the UK Financial Services Compensation Scheme, up to a limit of £50,000.

If you are willing to take a small amount of risk with capital, there are even better returns to be found by investing in corporate bonds. Yields of more than 6 per cent can be earned by sticking with good quality funds which invest in top companies – such as M&G Corporate Bond or Invesco Perpetual Corporate Bond fund. Managers will also tell you that if you are willing to hold on for the longer term, you should see some capital appreciation too.

With interest rates so low, it's crucial you review your savings now, to ensure you're getting as good a return as possible.

What it means... for borrowers

If you're lucky enough to have a tracker mortgage, yesterday's Bank rate cut will have signalled yet another fall in your monthly payments. For some, there may no longer be any interest to pay at all.

For homeowners on fixed deals, however, the latest drop in rates may not have as positive an effect as you might hope. New mortgages are still hard to come by, and unless you have a deposit of least 25 per cent to put down, you're unlikely to find a deal which charges anything less than 5 per cent. For those who don't need to borrow more than 75 per cent or even 60 per cent of their property values, there are now some very decent rates around – and these deals could well improve in the coming days. If you need to borrow 90 per cent or more of your property's value, however, you will find it difficult to get a mortgage at all – and should expect to pay 6 per cent or more if accepted.

If you can't get a new mortgage when your current deal comes to an end, then you will have to revert to your lender's standard variable rate (SVR). Most (not all) lenders have been cutting their SVRs as the bank rate fell – so if you're coming off a fixed-rate deal, switching to the SVR should mean making savings.

James Daley, Personal Finance Editor