It’s been a year since the Bank of England’s (BoE) Monetary Policy Committee (MPC) voted to halve the base rate of interest from 0.5% to 0.25%.
The move to take the base rate to a new unprecedented low came in the aftermath of the Brexit referendum, with the BoE, lead by Governor Mark Carney, aiming to calm markets unnerved by the unexpected result.
However, the move was criticised by some as acting too soon, after the British Economy continued to enjoy a period of steady growth until well into 2017.
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- The base rate of interest is set by the Bank of England (the UK’s central bank or ‘lender of last resort’), it’s the rate that commercial banks can borrow money at
- It is normally cut during recessions to stimulate economic growth and raised during economic booms to collar inflation
- A lower base rate is good news for borrowers who will find loans, credit cards and mortgages cheaper, but those with savings will be hurt by poor returns
Was the base rate cut the right move?
What has happened to mortgage rates?
Mortgage rates have steadily been falling ever since the BoE took the base rate down to 0.5% in 2009. Though standard variable rates have been slowly and steadily increasing since they first steeply dropped in 2009.
There was some uplift of rates around the “Trumpflation” effect after Donald Trump won the US presidential election, but mortgage rates on average remained on a steady downward trajectory, doubtless helped by the BoE’s decision to reduce the base rate.
However, last month the Council of Mortgage Lenders stated that mortgage rates were unlikely to fall much further and that they might even begin to creep up, despite the base rate remaining low.
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What has happened to savings rates?
The base rate cut has been hard on savers, with savings rates languishing at low levels ever since the base rate was initially slashed to 0.5% in 2009.
There was some recovery in 2011 (a possible consequence of the introduction of the FSCS deposit guarantee), but rates have slowly fallen again since then. You can see a marked decline in savings rates after the BoE cut the rate last year.
To provide some respite for savers, in his last budget the former Chancellor George Osborne, made the first £1,000 (or £500 for higher rate taxpayers) of interest earned from any savings account tax-free.
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What happened to credit cards?
The low base rate seems to have not had a strong effect on credit card APRs or overdraft interest rates, with these steadily increasing over the past few years.
Overdraft interest increasing is a possible consequence of the lack of competition in the bank account sector, with current account switching remaining relatively static, despite the introduction of the seven-day switch guarantee a few years ago.
The increase in credit card APRs may be due to more credit-building and credit cards for those with poor-credit entering the market. These cards generally have higher APRs and would lift up the average.
However, 0% interest periods for credit cards have been getting progressively longer, you can see that in the chart below (based on uSwitch data).
At the time of writing, with a market leading balance-transfer card you could defer paying interest on existing card balances for three and half years, and you can avoid paying interest on new purchases for just under three years.
Will rates ever go up again?
Governor Carney stated in a press conference held after the August 2017 inflation report was released that “households are less vulnerable than they were” and that rates will rise “if and when necessary”.
So, essentially should inflation get out of hand or the economy demonstrate consistent and robust growth the BoE will raise rates.
It’s also worth noting that the BoE’s US equivalent, the Federal Reserve raised the US’s base rate, and historically UK and US rates have been closely tied.
But, despite inflation exceeding targets at the start of 2017, it has tailed off over the summer. And the last BoE inflation report painted a sluggish picture of growth.
So, six members of the eight-strong MPC voted to keep rates at current levels, which was a step back from the three to five vote split in July 2017.
What could a rate rise look like?
Before the outcome of the Brexit referendum, it was thought that interest rates were unlikely to fall further, all the talk was about when a rate rise was going to happen.
And while they were vague about when this rise would happen, the BoE had been reasonably transparent about what a rise would look like. The plan was to gradually bring rates up to around half of the “historical average”, so this would mean slowly bringing rates up to 2.25% over a number of years.
But as the rate cut last August showed, without a crystal ball it’s impossible to guess the future and know how the BoE will respond.
The “extraordinary circumstances” of Brexit
The BoE is operating in “extraordinary circumstances”, stated Governor Carney, referring to uncertainty on the economic impacts of Brexit.
But he emphasised “it’s not what the Bank [of England] thinks, it’s what households think”, explaining that the BoE doesn’t have any more insight on the potential outcome of the Brexit negotiations than households do.
So, much of the current planning on how to handle monetary policy is based around interpreting the confidence levels expectations of UK households. Though, Governor Carney did stress that the BoE has “sustained contingency plans for all outcomes around Brexit.”
What do households think?
UK households seem to have a pessimistic view of the “general economic situation” according to data from the Office of National Statistics (ONS), but they are more optimistic about their own finances.
This is based on the Eurobarometer index, where a positive number indicates more confidence and negative indicates lower levels of confidence.
Which would seem to fit with Governor Carney’s assertion that households are in a better situation than they were, but remain stretched.