Will the recent Base rate cut work?

Sunday, 11th January 2009 11:48 - by Resident IFA

I took a telephone call on Friday morning from a Finance Journalist at a free, county-wide weekly newspaper. Her questions centred around gaining my comments on the Bank of England’s 0.5% cut made to the Base interest rate on Thursday 8th January. The questions were: - What did I think of it? - Will it work in stimulating the mortgage and housing market? - If interest rates decrease to 0%, will mortgage lenders end up paying their customers holding Base rate-linked products that actually discount from it i.e. ‘Base minus 0.05%’? My opinion is just that…one of many…some educated, some less so. So that puts paid to the first of the above three questions! As for the second question, such rate changes have a ‘lag’ period, perhaps 3 to 6 months, before any discernable impact can be seen or felt. It appears to me that it relies on lenders passing this cut on. Some have within their Base rate or Standard Variable interest products, but there are still a lot of mortgage customers who prefer the security of a fixed interest rate, this sector lagging behind and showing a paucity of decent rates. I think we have to remember that lenders are facing the dual issues of being responsible looking into the future and being responsible at present in their lending decisions. For a 3 or 5-year fixed interest rate product, you will be lucky to find many products under 4.5% and 5% respectively. Lenders have to judge their liabilities at those points in the future. Who’s to say that the Base (and LIBOR) rate won’t be a lot nearer 5% in 5 years time? The second part is now. Mortgage lenders have returned to financial prudence, asking First-time buyers to have at least 15% deposit in most cases - 15% (plus associated costs) of, say, £150,000 purchase price is a lot of money to save up in this current climate. So, a stimulated housing market largely comes from First-time buyers, and they are still finding it mightily difficult. The third question about lenders actually paying their ‘Base minus’ customers to hold mortgages if interest rates drop to 0% is good copy, but not keeping CEO’s awake at night, I am sure. Firstly, the Base rate still has 1.5% to go before hitting 0%. My hunch is that they wouldn’t reach 0%, perhaps the 0%-0.25% the Americans currently have, and thus the 0.25% would be invoked by lenders to keep such Base rate Tracker mortgage products above 0%. I also would question how many lenders have customers on these products – perhaps in the tens of thousands, but not hundred of thousands or millions, the financial impact not being huge to them. Besides which, most such products were only ‘Base minus’ 0.05% or 0.1% - again, not huge. Finally, the lenders may try to invoke a ‘force majeure’ legal argument, whereby the extreme economic circumstances allow a floor of 0%, not below. If rates do lessen towards 0%, one thing is for sure, customers on decent historic Base rate Tracker products will be well-off…but lenders less so! Until next time…