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4 August 2016

Everything you need to know about the Bank of England base rate cut

The Bank of England cut the base rate for the first time in more than five years. 

By Julia Rampen

On Thursday, the Bank of England cut the Bank’s base rate for the first time in more than seven years. The decision to slash it from 0.5 per cent to 0.25 per cent comes after weeks of speculation that the central bank must act. 

It may not seem like much. But a move in the base rate is something that reverberates around the world. 

The Bank’s monetary policy committee said it was presented with a “trade-off” between meeting inflation targets and stabilising activity. It stated: “Following the United Kingdom’s vote to leave the European Union, the exchange rate has fallen and the outlook for growth in the short to medium term has weakened markedly.”

It said it was “appropriate” to provide additional stimulus to the economy, in the form of lower interest rates, cheap funding for banks and an expansion of the asset purchase programme that underpins quantitative easing.

Speaking later at a press conference, Bank of England boss Mark Carney said banks had “no excuse” not to pass on the rate cut. Santander has confirmed it will do so, but other banks have been more reticent. 

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The decision has the potential to affect everyone in Britain, from savers to mortgage borrowers and those relying on public services. This is what you need to know.

1. The Bank rate is already historically low

Like other major central banks, the Bank of England slashed rates in response to the global financial crisis. When it dropped the rate to 0.5 per cent in March 2009, it hoped to ease pressure on mortgage borrowers and give the government breathing space to deal with debt.

Before that, the Bank base rate had been considerably higher – it was 5.75 per cent in July 2007 and 7.25 per cent in October 1998. 

2. The Bank was expected to hike rates, not drop them

When the current governor, Mark Carney, arrived in July 2013, most financial commentators saw his main task as gradually raising the Bank base rate to a “normal” level as the economy recovered.  He even set out conditions in a bid to curb speculation. The fact that the Bank of England is now cutting rates demonstrates how significantly the economic environment has changed. 

3. The Bank rate affects mortgage rates

Homeowners with a variable, or tracker, mortgage pay a monthly rate that is pinned to a lender’s standard variable rate, which in turn is pinned to the Bank of England’s base rate.  A cut in the base rate is good news for them. Imagine a family paying back a 20-year mortgage worth £250,000 at a rate of 2.86 per cent. If this dropped to 2.61 per cent – a quarter point drop – the Council of Mortgage Lenders calculates they would get a £32.80 discount each month. 

4. There is even less incentive to save

The Government wants to encourage saving, but there has been little reward for doing so since the financial crisis. Banks also model their variable savings rates on the bank base rate. Holly Mackay, the founder of Boring Money, said: “Those with cash savings will need to reassess their strategy as interest moves from poor to dire.”

5. The Bank Rate affects government spending

The government is also a borrower, and it seems to be moving towards a strategy of investment in long-term projects to stave off a recession. 

As Mitul Patel, head of interest rates at Henderson Global Investors, told The Staggers in July: “Lower interest rates will lower borrowing costs for the Government. It will make borrowing for infrastructure cheaper.”

6. The pound will weaken further

The value of the pound has already slid in anticipation of a cut. Caxton FX analyst Alexandra Russell-Oliver said: “While markets may already be pricing in a rate cut, there is still room for further sterling weakness.” After the announcement, the pound slumped to $1.31 and €1.18. 

7. The rate cut is only part of the stimulus

The Bank noted that because the base rate was already so close to zero, banks and building societies might not wish to cut rates anymore. So the Bank is introducing a “Term Funding Scheme” that will provide funding for banks at cheap interest rates. This should in theory make it easier for them to pass on savings to borrowers. The Bank is also expanding its asset purchase programme, which lowers the yield on government bonds and is designed to lower the costs of borrowing for households and businesses. 

8. No one knows what happens next

The previous Bank of England governor, Sir Mervyn King, was clear that loose monetary policy – low interest rates and quantitative easing – was designed to give the Government “breathing space” to fix the economic crisis. 

But as well as the Bank of England, other central banks, such as the European Central Bank and the Bank of Japan, continue to loosen  monetary policy. 

The interest rate specialist Mitul warned: “The scope for further cuts is fairly limited.”

In other words, central bankers have only so many tools at their disposal. And they’re now using them to enter unprecedented territory.