The Bank of England has cut its base rate from 0.5 per cent to 0.25 per cent, a new historic low, in order to help the overall economy deal with the post-Brexit vote economic shock.
But what will this move by the Bank mean for the finances and economic prospects of ordinary UK households?
Lower mortgage repayments...
Traditionally, a cut in rates by the central bank meant a reduction in people’s monthly mortgage repayments. And people on tracker mortgages – where repayments vary with the Bank of England’s base rate – should indeed benefit from a Bank of England cut.
As an illustration, someone with a 25-year £250,000 repayment tracker mortgage paying 2 per cent interest could see their monthly £1,100 repayment fall by around £30 if rates do go down to 0.25 per cent.
However, the number of people on tracker mortgages has fallen in recent years as people have been moving on to fixed-rate deals in anticipation of an interest rate rise (not a cut) from the Bank.
In 2015 almost 90 per cent of news loans were fixed rate as people sought to lock in low rates for a couple of years. If you’re on one of these deals you will not benefit from a reduction in the base rate.
A lower cost of borrowing for businesses...
Another traditional rule of thumb regarding movements in the Bank of England base rate was that cuts meant cheaper borrowing for businesses. And this was one of the main objectives for the Bank, since lower borrowing costs were supposed to boost investment and hiring by firms.
Yet there have been two impediments to this transmission mechanism since the financial crisis. The first is that banks have been rather slow to pass on the reduction in the general cost of borrowing to firms. The second is that there seems to have been muted demand from companies to borrow.
So if you’re a small business owner looking to get a loan there may be disappointingly little difference in the attitude of your bank to your application as a result of a cut. And you also may still not feel tempted to seek a loan in the first place.
However, there is another bank scheme to boost business lending by banks called the Funding for Lending Scheme. And that may also be ramped up shortly.
Charges on savers' deposits...
The Royal Bank of Scotland created a shockwave last week when the majority state-owned lender wrote to 1.3 million of their business customers warning that they might impose charges on credit balances if the Bank of England ultimately turns its base rate negative.
This is because cuts in the base rate by the Bank crush the private banks' profit margins when rates are already close to zero.
It’s unlikely a cut in the base rate to 0.25 per cent will result in charges. But this is certainly something to be wary of further down the line if you are a small business owner with cash in the bank. It may be a good reason to shop around for a different bank, one that commits not to impose charges.
As for ordinary depositors, in theory they should also be in the firing line for charges on positive cash balances if the base rate turned negative. Their interest rates have already collapsed in recent years to a measly 0.4 per cent a year on instant access savings accounts.
However, retail depositors are highly valued by banks as a source of funding and it would create an avalanche of bad publicity for the financial sector if they hit ordinary savers in this way.
So lenders are likely to swallow the hit to their margins themselves from lower base rates. More likely is that they will steadily withdraw the best value savings accounts from the market, something that is already happening.
Bigger pension fund deficits...
When the Bank of England base rate falls the effective interest rate (or yield) charged on government borrowing also tends to fall. These yields are already extremely low and this has a nasty knock-on effect of boosting the nominal value of the liabilities of defined benefit company pension schemes.
It’s estimated that the aggregate deficit of all such schemes in the UK is now more than £900bn – up from £825bn before the referendum due to sinking government bond yields.
When these deficits rise there’s an indirect negative effect on workers. Company bosses may feel pressure to put spare company cash into schemes to reduce the deficits. And in response they may curb wage increases for existing employees. So be wary of this danger if you work for a major company with a large, historic and generous pension scheme.
Share price rises...
Another side effect of cuts in Bank of England base rates is a boost to share prices.
So, in theory, a cut should increase the value of your savings pot if your savings are held in stocks and shares.
However, financial market traders always look to make a profit by "pricing in" expected events before they happen if that’s possible and a cut has been widely signalled by the Bank‘s Governor, Mark Carney since the week after the Brexit vote.
So to the extent that a cut in the base rate is already priced in, there may be little movement in share prices in response to an actual base rate cut.
More expensive holidays...
Interest rate cuts are often associated with falls in the exchange rate, meaning a weaker pound and therefore more expensive holidays for Britons travelling abroad.
Yet as with share traders, foreign exchange market traders seek to price in events before they happen, meaning that there could actually be little immediate reaction from sterling versus the euro and sterling versus the dollar.
So if you're going on holiday soon it may not be such a great idea to change your sterling before the Bank's decision is announced.
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