Another Base Rate Cut May Not Help

by Harvey Jones on 03 February 2009  |  67 comments
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A further cut in the base rate won't help lots of people. In fact, Harvey Jones reckons it may do more harm than good.

Almost everybody expects the Bank of England to hack at least another 0.5% off base rates on Thursday, and most people still talk as if this is a good thing.

And it is, for some people. The problem is that the people who will benefit most have already benefited from previous cuts, while many who urgently need help won't see any gain from this latest attempt to use interest rates to bludgeon the economy into life.

In fact, many will suffer active harm.

Money, money, money.

There is no doubt that some people will be very happy if base rates are cut further, and who can blame them.

If rates drop, say, from 1.5% to 1% (a 33% cut!) anybody with a collar-free tracker mortgage will cash in. If they have a £100,000 mortgage, they will save £42 a month on top of all the savings they have banked in recent months.

Their interest payments will have crashed from £417 a month to just £83 since October, when base rates stood at 5%. That has given them an extra £334 to pump into our ailing high streets.

A small number of lucky tracker borrowers with Alliance & Leicester and C&G may be able to regale dinner party guests with tales of how they are benefiting from that strange quirk of the crunch, the 0% mortgage.

Some borrowers on SVRs (which includes me) should also benefit, provided their lender passes on at least some of it.

The trouble is, these people have already feasted on plenty of choice cuts in recent months, while others are sitting starved at the table.

Pain, no gain.

Anybody who took out a fixed rate mortgage before the base rates bonanza will have yet another reason to rue their decision. So will any borrower who didn't spot the small print in their tracker mortgage describing something exotic called a collar.

Or who is stuck on an SVR with Barclays (5.49%) or Alliance & Leicester (5.09%), rather than the more generous rates offered by C&G or Nationwide (both 3.5%).

Many of these borrowers won't be able to remortgage to a cheaper rate, either because they face early redemption charges, or don't have enough spare equity to secure a competitive deal.

So the main effect of another base rate cut will be to hand out even cheaper money to those who are already paying rock bottom rates, and ignore the rest.

Oh, and give lenders yet another chance to improve their margins at the expense of their customers.

Cuts? What cuts?

Base rates may be at historical lows, but you would never guess by looking at other forms of credit, such as personal loans, credit cards and overdrafts.

In the last 18 months, the average APR for a £5,000 unsecured personal loan leapt from 8.6% to 12%, a rise of almost 40%, according to Moneyfacts.

Since January 2009, the average authorised overdraft rate has increased from 13.01% to 14.68%, Moneynet says.

And typical APRs on leading credit cards have risen from an average 16.8% to 17.7% in the last 12 months, Defaqto says.

Base rate cuts clearly aren't helping cash-strapped to debtors with these forms of credit.

Jesus saves. No-one else does.

Base rate cuts really do hit home if you have money on deposit, and find yourself at the sharp end of another quirk of the crunch, the 0% savings account.

The Building Societies Association (BSA) says that savers are now getting 75% less interest than before the run on Northern Rock.

Elderly people living off the interest on the savings have been hardest hit. The BSA says that for pensioners dependent upon their interest income from their savings, "prices would have to fall by an unimaginable 75% for them to maintain their living standards."

Many cash-strapped pensioners will be making up the shortfall by chewing up their capital.

Building societies and their subsidaries are currently responsible for 62% of net lending, helping to sustain what little activity there is in the market. If another base rate cut scares off even more savers, societies will see their supply of funds dry up, and be forced to slash their lending activities.

So further base rate cuts could have the perverse impact of squeezing lending even further, rather than encouraging it (hurting first-time buyers into the bargain).

It's the liquidity, stupid.

None of this would matter if base rate cuts did what they were supposed to do, and get bankers lending again (although more sensibly than before).

But the cost of money isn't the problem, it's the availability. Banks are still too scared to lend, whether to businesses or mortgage borrowers, and that is what is strangling the economy. They'd still be too scared to lend if base rates fell to 0%, as could happen quite soon.

Plenty of good, solid businesses are going to the wall, because they can't get the loans they need. Most could live with base rates at 3% or 4%, provided they can actually get a loan. But they can't, and money won't be easier to get on Friday morning.

Given its paucity of powers in trying to fend off the recession, the Bank of England probably has little choice but to follow the US and Japan in slashing interest rates ever lower.

The trouble is that a 0% interest rates are no magic economic bullet. Just look at Japan, which has been shooting blanks for 15 years.

The Bank of England and Government need to find a better way of injecting liquidity back into the market - and fast.

I'll save money if base rates are cut on Thursday, and so will some of you. But that doesn't mean it's the right thing to do.

More: The Base Rate Cut -- One Month On

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