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Demand switches from rates to supply

Last October, the clamour for the Bank of England to reduce bank rate and get some liquidity back into the economy was deafening. With the economy sliding rapidly into recession and the mortgage market at its lowest level for many years many organisation were calling for the Bank of England to take some action. The 1.5 per cent reduction in November was warmly received as a dramatic but justified response to the situation.

But six months and a total reduction of 4 per cent later, the reaction seems to have changed. Far from welcoming the latest 0.5 per cent reduction announced earlier this month, the growing consensus is that the rate cuts have gone far enough.

There appears to now be a feeling that the reductions in interest rates have not had the effect they should have and the bank should stop cutting rates.

Charles Stanley chief economist Edward Menashy said of the last rate cut: “More out of exasperation than conviction, the monetary policy committee of the Bank of England has cut base rates by 50 basis points to 1 per cent. It must be asked, why, if a total of 375 basis points of rate cuts have not arrested the decline in demand, that a further 50 basis points should suddenly kickstart the UK economy?”

Bestinvest senior investment adviser Adrian Lowcock sums up the feeling of many when he says: “Cutting the base rate further is a bit of a moot point. The banks have still not passed on the last cut, except to their tracker mortgages. Savers are already getting next to nothing on their cash. Until the banks have the confidence to start lending again, rate cuts themselves will not work.”

The Route City wealth club head of research and development Simon Pimblett says: “The only real impact that a base rate reduction has is in cutting interest payments to savers. Evidence from the wider economy tends to suggest that the lending market has become desensitised to changes in base rate, and that actual real world lending rates (where credit is available) are already tending to floating at around their lowest practical level.”

Mortgage brokers have been among the loudest voices calling for rate cuts but now even some people in the in the mortgage market are beginning to question the wisdom of continual rate cuts.

Mortgage Advice Bureau head of lending Brian Murphy says: “With almost every month appearing to signal yet another base rate cut, it surely begs the question, how much further can the MPC go?

“Despite continuous rate cuts the economy is officially in recession, and it has now become apparent that it will take more than BBR reductions to kickstart it. Further tactics need to be implemented in order to aid both struggling borrowers as well as those who remain unable to get a foot on to the housing ladder.”

Building Societies’ Association director general Adrian Coles says the low rates now on offer are not only bad news for savers but are also bad for borrowers: “The rate cut is an assault on savers who will have seen their interest payments drop by 83 per cent since July 2007. Savers dependent on interest income have not seen prices fall by a similar amount – their lifestyles have taken a significant blow.”

If the number of savers drops this has a knock on effect on the funds available to lenders. Coles says: “People are less likely to save and the flow of funds into the mortgage market will be further disrupted.”

Pimblett says he is hopeful that the rate-cutting cycle has now come to an end. He says: “With the base rate having been cut so far and so fast over the last few months, it would now make sense for the Bank of England to assess the real impact on the economy before considering any further changes. This further cut in base rate was widely predicted but we have probably now reached the end of the rate-cutting cycle.”

Institute for Public Policy Research senior economist Tony Dolphin says previous rate cuts have been needed but the bank should start to look at other options to stimulate the economy and get money flowing again.

“Desperate times require desperate measures and, with the UK and global economies probably in the midst of their worst recessions since the 1930s, and in the absence of inflation pressures, it is right that the monetary policy committee is taking action to help alleviate the downward pressures on the economy. Historically, low short-term interest rates are an appropriate response.

“However, cuts in short-term interest rates may now have reached the limits of their effectiveness and it is time to focus more on quantitative easing measures. For example, the Bank of England could buy government and corporate bonds which would bring down longer-term interest rates, making it cheaper for companies to raise cash.”

The good news for those who do not want further rate cuts is that the Bank of England is now actively looking at using other measures than simply manipulating the bank rate to stimulate the economy.

At the publication of the bank’s quarterly inflation report last week, Bank of England governor Mervyn King announced the beginning of a programme of quantitative easing to stimulate the supply of cash in the economy.

He said that as early as next month, the bank would begin to use its funds to purchase gilts and corporate bonds to increase the supply of money.

The bank is allowed to take such measures under the terms of the Asset Purchase Facility announced by the Government in January. The APF takes over from the special liquidity scheme set up last year and used to the provide emergency liquidity to banks by swapping illiquid assets for treasury bills has provided the Bank of England with the means to increase money supply into the economy.

But, as the inflation report explains: “If movements in bank rate do not prove sufficient to meet the inflation target, the Asset Purchase Facility announced by the Government on 19 January provides a framework for supplementing the MPC’s conventional policy instrument.

Or to put it another way, if it looks like the economy is going to drop under its official target for inflation of 2 per cent and reductions in bank rate are not having any effect, then, under the terms of the APF, the bank is allowed to start purchasing large volumes of commercial bonds to get more money into the system.

King maintains that this measure is purely targeted at inflation, which the monetary policy committee predicts will drop substantially below 2 per cent in the medium term, rather than printing money just to increase the amount in circulation.

King says: “We will be buying a range of assets, certainly including gilts, in order to ensure that the supply of money will grow at an adequate rate to keep inflation at the target and that normal rates of economic growth can resume.”


Figure skating

I will be happy to put my money into personal accounts if they can guarantee me an annualised return of 5.1 per cent above inflation. Sadly, even such ambitiously high performance figures will not be enough to make personal accounts an appealing prospect for many low or average-earners with 20 years or less to retirement.

Lower the lapses

Times are going to get tough. Protection sales have escaped the ravages of the credit crunch and recession so far, while mortgage and investments have taken an almighty battering, but this period of calm can’t last forever. Not only will sales be hit at some point but also lapse rates will start to increase as more people lose their jobs and try to save money by cancelling their protection policies.

One day wonder

And the spotlight is on Standard Life… Again. This time the firm is being lambasted for guaranteeing annuity quotes on its own pension policies for just one day, compared with an industry average of two weeks.


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