Base rate cuts: What does it all mean?

So, after 90 long months of base rate inertia, the Bank of England’s Monetary Policy Committee have finally decided to pull the trigger and cut rates to new record lows of 0.25 per cent. In the wake of the EU Referendum result, it was a decision widely anticipated with the economy slowing as it has, and growth forecasts for the short term generally looking grim.

Nevertheless, for the vast majority of those 90 months, many would have thought the next change would have been an increase, and the cut doesn’t leave Governor Mark Carney a great deal of wiggle room before negative interest rates become a reality – albeit that he is quoted as saying that he is “not a fan” of going down that route.

It’s an understandable response to the post-Brexit uncertainty, but the question on everyone’s minds is: what exactly does this cut in base rates mean? It’s gift-wrapped as a flood of money being injected into the economy, and a stimulant for growth. But will this actually equate to a boom, and more money ending up in our pockets?

The logic and benefits to a cut

Carney has announced that the Bank will be printing an additional £60 billion in money, taking the total of the so-called quantitative easing programme up to £435 billion since the 2008 financial crisis. In addition, the Governor also revealed plans for a £100 billion funding scheme for banks, along with a £10 billion corporate bond buying scheme.

The idea behind all of the above is fairly straightforward. The stock market has responded favourably in most quarters already, while the stimulus to the economy from an influx of money should enhance liquidity and (hopefully) stave off fears of a recession as a result.

In essence, the interest rate is the price of money, so the lower it is, the cheaper it becomes to borrow money. This encourages people to make purchases they might not previously have been able to afford, while the subsequent fall in mortgage prices (albeit that the likes of Lloyds and Natwest have yet to commit to this) will bring a raft of new buyers into the housing market. In fact, the Council of Mortgage Lenders estimates that for those who borrow £200,000 over 25 years, the base rate cut will equate to a £26 saving per month, while those borrowers on variable rate or tracker mortgages will also end up making significant savings almost immediately.

And now the downside(s)…

Unfortunately, any policy decision within economics is a double-edged sword, and there are winners and losers. Pensioners and savers will be the ones most despondent at the news. Variable rate savings accounts have already been hit, and although surges in the FTSE 100 will have benefitted some pensioners’ portfolios, the vast majority will suffer with falling savings and annuity rates.

Inflation is also an inevitable consequence of an expansionary monetary policy. This may well be part of the plan for Carney and Co., and with the UK’s quarter-on-quarter CPI reports over the last couple of years persistently hovering around zero, there is plenty of room to breathe in this regard, and some would even argue that an inflation rate closer to two per cent is healthier. Yet, even accepting this school of thought, the bottom line is fewer pennies in the consumer’s pocket.

Compounding this, an interest rate cut has the direct knock-on effect of devaluing the currency, as, in line with economic theory, the pound will now offer foreign investors an inferior yield. This has already been reflected in practice as the sterling plummeted to the post-Brexit, 31-year record lows against the dollar on Thursday.

And a devaluing currency is unambiguously inflationary, as it impacts the cost of imports, and thus, further down the funnel, the prices of consumer goods. The fear is that, with growth forecasts now being downgraded for 2016 and 2017, we could be heading for ‘shrinkflation’.

Base rates and peer-to-peer lending

We must again emphasise that the link between Bank of England rates and our lender returns are, at most, tacit. The rates on our three and five-year terms are almost exclusively determined by the equilibrium of demand and supply of funds between borrowers and lenders, which means it is consumer behaviour, rather than policy, which determines annualised rates.

A recent survey we did of our lenders suggested concerns among some that rates in peer-to-peer lending (P2P) could be suppressed, and indeed our five-year rate has dropped slightly over the last month. However, this has been purely down to a relative influx of lender capital since the Brexit vote, which, in our opinion, underscores the fact that P2P may become even more attractive in the future. Furthermore, our three-year rate has held firm, and although we cannot predict or guarantee what will happen in the future, we are confident that our rates will continue to offer investors a good-value alternative in terms of risk and reward.

Digesting the status quo

Certainly a base rate cut – even one as small as 0.25 per cent – is a significant event in light of the uncertainty engulfing the UK economy. Added to this, Carney has hinted that further cuts could be on the way, which could exacerbate the consequences highlighted above.

By no means are we criticising Thursday’s decision, and the Bank of England has acted decisively over the last two months with the health of our economy in mind – as their remit commands. However, while many will be hailing cheaper loans and mortgages and a cash-boost to the economy, it’s important to realise that it is not all one-way traffic, and that the power of the interest rate – although significant – has its limits. The rest is down to sound fiscal policy, encouraging foreign investment and trade, consumers keeping calm and carrying on, and, as ever, a good dose of economic luck.

Main image "The Financial Stability Board" by James Oxley. Image subject to copyright. A link to the image and appropriate licence can be found here. You must not use or reproduce this image other than in accordance with the licence.

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