Sean O'Grady: Rate cut puts Britain in uncharted waters

The UK economy embarked on uncharted waters after the Bank of England cut interest rates to their lowest in its 315-year history. The half percentage-point reduction to 1.5 per cent is lower than anything seen during the course of two world wars, the Great Depression, the Napoleonic Wars, countless stock market crashes and the rise and fall of the British Empire.

The Bank's Monetary Policy Committee (MPC) has slashed the official cost of borrowing by 70 per cent in three months. The cut might have been larger, but for worries about sterling. The Bank warned of the "unusually sharp and synchronised downturn" facing the world, and that "output is likely to continue to fall sharply" in the UK.

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However, the indications are that the Government and the Bank are likely to go even further and in new directions in the next few weeks.

The problem remains the availability rather than the cost of borrowing and the inability or unwillingness of the banks to pass on rate cuts, especially for new mortgage customers with limited deposits.

The Halifax, the UK's biggest lender, said that, "all mortgage customers with a variable-rate mortgage will benefit, in full, or in part, from today's reduction". However, doubts persist.

Peter Bolton King, the chief executive of the National Association of Estate Agents, explained: "The fact is that, without the major lenders passing on this cut and without stronger commitment from the Government to fully address the problems of the housing market, this cut is practically an exercise in spin."

Ian McCafferty, the Confederation of British Industry's chief economic adviser, said: "Today's cut reflects the Bank's recognition that interest rate reductions on their own cannot restore credit flows, the most important factor determining the prospects for the economy." As the base rate approaches zero with a seemingly limited impact on the availability of credit in the economy, which the Bank said "has tightened further", other options are being evaluated.

One idea that has been actively discussed is so-called "quantitative easing", more colloquially known as "printing money". This would involve the authorities buying savagely devalued "toxic assets" – mortgage-backed assets and others – owned by the banks. Something of the kind has been already begun in the US under the "Paulson Plan" or Troubled Asset Relief Program (Tarp). The funds thus directly injected into the banks could then be used to support lending to first-time buyers, small businesses and other groups hit hard by the credit crunch.

Yet there was some confusion yesterday as to how enthusiastic the authorities are about such a move. Having said earlier this week that he was considering a policy of quantitative easing, with speculation that the Bank of England was less keen on the notion, the Chancellor Alistair Darling, said instead that, "there's a debate to be had about what you do to support the economy as interest rates approach zero, as they are in the United States.

"But, for us, that is an entirely hypothetical debate. We are looking at a range of measures to support the economy, to support business and to help people. But nobody is talking about printing money."

By contrast, the MPC hinted that such unorthodox policies might have attractions: "The availability of credit has tightened further, pointing to the need for further measures to increase the flow of lending to the non-financial sector."

That could also mean another round of recapitalisation of the banks and, most likely of all, some form of national loans-guarantee scheme. In the past, the Governor of the Bank, Mervyn King, has spoken approvingly of bringing together the various loan-guarantee schemes now being operated or considered by government. These include the inter-bank guarantee scheme, amounting to hundreds of billions of lending, the small business loan-guarantee scheme, the long-established export credit guarantee shame, and the proposal in Sir James Crosby's review to revive mortgage-backed securities.

The shadow Chancellor, George Osborne, accused Mr Darling of being "careless". "Gordon Brown has led Britain to the brink of bankruptcy," he said. "Printing money is the last resort of desperate governments when all other policies have failed.

"It can't be ruled out as a last resort in the fight against deflation but, in the end, printing money risks losing control of inflation. And to float the idea carelessly is irresponsible in the extreme as it risks losing the confidence of international markets."

The Liberal Democrat economy spokesman, Vince Cable, said: "Unless the lending market can be quickly unfrozen, ministers will have to investigate whether one of the state-owned banks can be used to increase lending to businesses."

The Bank may feel the time for "printing money" may have to wait until rates fall closer to zero. Most City economists expect rates to fall to 0.5 per cent, or below, by the summer.

Winners and losers: How the Bank's decision will affect you

Savers

The Bank of England interest rate has fallen from 5 to 1.5 per cent in three months and sadly, most bank and building societies have cut their savings account rates by a similar margin.

According to Moneyfacts, the average savings account now pays just 1.48 per cent interest which, with inflation at still over 3 per cent, means most people's savings are not even keeping up with the cost of living. Yesterday's rate cut means this situation will only get worse over the coming weeks as most banks and building societies cut their savings rates by another 0.5 percentage points.

The good news is that, for the moment at least, there are still a handful of accounts paying more than 4 per cent interest. ICICI's one-year fixed-rate savings bond, for example, is paying 4.65 per cent and Anglo Irish's one-year fixed-rate bond pays 4.6 per cent. Both of these are 100 per cent guaranteed under the Financial Services Compensation Scheme, up to £50,000. If you need instant access to your money, Anglo Irish is offering 4.55 per cent, although this rate could fall.

First-time buyers

The rate cuts have not had much of an effect on the cost or availability of borrowing for first-time buyers – especially those with a small deposit.

According to David Hollingworth of the mortgage broker, London & Country, the best deal available for a first-timer with a 10 per cent deposit is a two-year fixed rate of 5.69 per cent – almost four times higher than the Bank of England rate. Furthermore, if you're looking for a tracker mortgage, there's nothing available at all unless you have at least a 20 per cent deposit. Although the Bank rate may be cut again, Mr Hollingworth doubts further cuts will have much effect on the cost of borrowing for those with small deposits. The main problem is the banks don't have the money to lend.

Existing mortgage holders

If you've got a tracker deal, yesterday's Bank rate cut will further reduce your monthly payments. However, for the majority, who are still on fixed-rate deals, the main worry is whether you'll be able to remortgage once you come to the end of your current deal. Unfortunately, the rate cuts have done little to improve remortgage deals for anyone except homeowners whose home loans are worth less than 75 per cent of their property's current value. If you're looking for a loan of less than 75 per cent, Mr Hollingworth says you can get a two-year fixed rate deal of 4.29 per cent with Cheltenham & Gloucester. And if you're mortgage is worth less than 60 per cent of your home's value, Mansfield Building Society is offering a two-year fix at 3.99 per cent.

Those who have little or no equity in their homes, and can't remortgage, will be placed on their lender's standard variable rate (SVR), when they come to the end of their fixed deal. Fortunately, SVRs have been coming down as the Bank rate has been cut. Nationwide, Lloyds and HSBC all said they would cut their SVRs by the full 0.5 percentage point yesterday.

Pensioners

Falling interest rates are proving disastrous for pensioners who are living off an income from their savings. Furthermore, rates on annuities – products which turn your pension pot into an income for the rest of your life – have also been dropping. And yesterday's Bank rate cut will only make the situation worst. Pensioners looking for income may be better to consider conservatively managed corporate bond or equity income funds. Those who are thinking of buying an annuity should not waste any time, as rates are expected to only worsen in the short term.

James Daley, Personal Finance Editor