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Where next for interest rates?
By Rebecca Atkinson
Before the economic downturn, many people paid little attention to the base rate - the official rate of interest set by the Bank of England's Monetary Policy Committee (MPC). Despite the group of economists meeting each month to discuss and vote on whether the rate should rise, fall or stay the same, the outcome rarely made much of an impression - it certainly was very rarely front page news.
But since October 2008, when the MPC first starting to aggressively cut the base rate, the story has become a lot more interesting. We've seen the base rate fall from 5% to just 0.5% - an all-time historical low. At the same time, many tracker mortgage borrowers have been reaping the benefits, while variable-rate savers have been feeling the pinch.
The fact that the Bank of England has frozen the base rate for April shouldn't come as a huge surprise - after all, as the rate can't turn negative, it didn't have much scope for another cut.
At the same time, the latest inflation figures recently revealed that the official rate of inflation - known as the Consumer Prices Index - rose slightly last month. Some economists believe that this could increase further, mainly as a result of the Bank of England's quantitative easing measures plus the price rises seen in April.
If inflation does start to rise, then the Bank of England may well be forced to increase the base rate as well - higher interest rates calm consumer spending and are one measure used to bring inflation under control.
However, there is no guarantee that inflation will start to rise; we could actually see the opposite occuring, with deflation (i.e. falling prices) on the cards. The Consumer Prices Index is just one measure of inflation. The other, known as the Retail Prices Index, includes housing costs such as mortgage payments. This measure actually hit 0% last month - prompting forecasts that the UK could enter a period of deflation.
Charles Davis, economist at the Centre for Economics and Business Research, believes that the risk of inflation has been “overplayed”.
“The rise in inflation [seen last month] was mainly led by a reversal of January discounts,” he explains. “With unemployment rising at a record pace and annual earnings growth having dropped to 1.8% in January, the slackness in the labour market and falling consumer demand will help to put downward pressure on prices.”
As such, Davis predicts a period of deflation – which will probably prevent the Bank of England putting up the base rate until 2010.
Stick or twist?
A recent Moneywise poll revealed that 69% of users expect the base rate to be between 0.5% and 2% by the end of the year.
However, 15% believe the Bank of England will increase the rate to between 2% and 4%, compared to 12% who think it will cut the rate to less than 0.5%. A further 1% of users think the base rate could rise beyond 6% by the end of the current year.
The truth is, without the aid of a crystal ball, it's hard to know exactly where the base rate is heading. Much depends on inflation, and until the economists that make up the MPC get a clearer picture of whether this is increasing or slowing, the interest rate is far from set in stone.
As well as waiting to see what happens to inflation, the Bank of England is also likely to be waiting to see more evidence of the impact of monetary measures already taken.
Adrian Coles, director general of the Building Society Association, believes the base rate will remain at 0.5% for some time, in order for the central bank to assess the impact of previous rate cuts and the decision to start quantitative easing.
"It will take some time before the effectiveness of these policies becomes more clear,” he explains.
Alongside announcing the base rate freeze, the Bank of England also voted to continue its programme of quantitative easing – or creating new money – saying it had so far injected £26.4 billion into the economy by buying assets such as government and corporate bonds.
A further £50 billion is due to be put into Britain's economy. The central bank says this will take two months.
James Caldwell, director of Fairinvestment.co.uk, says: "It is unlikely that the base rate will creep back up any time soon, as the effects of quantitative easing have yet to be seen in the economy, along with other government initiatives."
Meanwhile, David Page, economist at Invectec Securities, believes that the economy could be starting to improve, meaning the second half of this year could see an end to the contracting economy.
"If that is so, the MPC is unlikely to provide further monetary stimulus after completing its quantitative easing operations," he adds. "Indeed, stabilisation in the second half of 2009 should see the MPC considering policy tightening [interest rate rises] in early 2010."
Savers
Official figures from the Bank of England reveal that rates on instant access, notice and fixed-rate accounts saw a slight uplift in March – but remain depressingly low.
Instant access deals, for example, now pay on average 0.19%, up from 0.16%. However, this is still a far cry from the average rates seen last March of 2.47%.
Fixed-rate deals have also become slightly more competitive, with average deals now paying 2.65%, up 0.02% from February. Again, however, they pay significantly less than last year, when average rates were around the 5% mark. Notice accounts, meanwhile, remained stagnant at 17% between February and March – down from 3.42% last year.
Despite the slight uplift on fixed and variable-rate accounts, cash ISA savers have little cause for celebration – rates actually fell in March, from 0.96% the previous month to just 0.63%. This means that in the past year, rates on cash ISAs are down a whopping 4.18%.
Savers have been hit particularly hard by the rapid decrease in the base rate. According to data provider Defaqto, 60% of instant access savings accounts now pay less than 0.5% on a £1,000 balance - and 50% pay less than 0.25%.
As a result, people's savings are now barely able to keep up with inflation, and could even be eroding in value rather than growing.
Coles argues that while savers haven't suffered another cut to interest rates this month, they won't see any respite from the falls already experienced.
"While savers will be pleased that rates have not been cut any further, this will do nothing to help those who have seen the income they earn on their savings diminish sharply in recent months," he says.
Mortgages
While some tracker mortgage borrowers have benefited from the falling base rate, some lenders like Nationwide have 'collars' in place which prevent rates from falling below a certain level. So, with each base rate cut, fewer borrowers have benefited.
At the same time, people with fixed-rate mortgage deals have seen no change to their monthly repayments. Those on their lenders' Standard Variable Rate may also have seen no change, as many lenders have chosen not to pass on the base rate cuts in full - if at all.
New mortgage deals, however, have got cheaper but only for people with big deposits to put down. Figures from data provider Moneyfacts show that two-thirds of mortgages currently on the market require buyers to put up a deposit of at least 25%.
However, if you've got your eye on a best-buy mortgage deal, then you'll need to stump up at least 40% upfront.
The decision to freeze the base rate in April won't benefit borrowers - but it is also unlikely to make things tougher for them either.
Coles says the freeze shouldn't "worsen mortgage availability". But that doesn't mean, of course, that it will improve it either.
However, Andrew Montlake, director of independent mortgage broker Coreco, says that the hold on the base rate marks the bottom of the interest rate cycle - meaning borrowers and potential buyers need to be careful not to miss the boat.
He explains: "The current strategy of quantitative easing, coupled with higher-than-expected recent inflation figures, means the base rate could be raised later this year to counter an inflationary threat. What this means is that time is running out for people to lock into historically low fixed rates, which are based on the expected future, rather than current bank rate.
"The window of cheap money that we are in could soon be closed."
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