UK interest rates fall to 0%?
Oxlade, This is Money
28 October 2008
rates are expected to be cut from 1.5% to 1% tomorrow. UK
rates are also forecast to
be slashed again starting at next week's MPC meeting. Some
experts say 0% rates are now possible both sides of the
Atlantic. Andrew Oxlade explains.
US rates been at 1% before?
Yes. They were
cut to 1% in June 2003 in a bid to boost the economy after
the invasion of Iraq. It also followed the dotcom bust of
2000-2002. Before that, the short Eisenhower recession of
1958 was the last visit to 1%.
about UK rates?
The recent low
for the bank rate was 3.5% in 2003. Before that it was after
the Great Depression. Rates were pegged at 2% for 25 years
from 1931. Any fall below 2% would be the lowest since the
Bank of England was established in 1694.
happened to rates so far this year?
The US Federal
Funds rate was slashed from 4.25% to 3.5% in January as
the credit crunch began to turn into a financial crisis
with the failure of investment bank Bear Stearns. Further
cuts came through the year with a 50 basis point reduction
to 1.5% on 8 October. It was part of a co-ordinated move
by central banks around the globe.
UK rate cuts
began in December 2007, falling from 5.75% to 5.5%. (See
the full history here or in the table below). That was followed
by quarter-point cuts in February and March and then the
half-point cut to 4.5% early this month.
are rates being cut?
wanted to cut rates more aggressively throughout 2008 -
they needed to increase the availability of credit and stop
the crunch turning into a financial and economic crisis.
But they were held back by surging inflation (see a history
of inflation). This was a factor separate from the credit
crunch and was driven by booming demand for oil and other
commodities in Asia, mainly China.
It looks clear
now that they failed to avoid the crunch rippling into a
recession, at least in Europe and the US. That recession
now means commodities demand has plummeted and inflation
is set to evaporate. In fact, the new fear is that we may
it will be a rate cut bonanza?
in the UK. US rates are relatively low already and about
to get lower. The British bank rate at 4.5% will probably
be cut by half a point at the MPC's monthly meeting next
Thursday (6 November) and possibly by another quarter-point
in December, to take the rate to 3.75%. Most economists
expect rates to slide to between 2% and 3% by the end of
2009. Other experts have talked of a worst-case scenario
of rates falling to 0%. See a full round-up of views below.
on - Iceland's economy is a disaster yet it has an 18% rate
the IMF demanded higher rates as part of a multi-billion
rescue package. The krona, Icelandic currency, has plunged
recently. Putting up rates, from 12% to 18%, helps strengthen
a currency - the higher yield attracts foreign investment.
That's partly why the pound has been tumbling - expectation
of lower UK rates.
UK rates fall to 0%?
It all depends
on two inter-dependent factors: recession and inflation.
So far, the economy has only shrunk for one quarter. Figures
are expected to show in January a further decline for the
current period, confirming the UK is in recession.
In the best-case
economic scenario, the recession is short and shallow. But
the danger then is that cutting rates too far would unleash
inflation, which is 5.2%, against a target of 2%. The MPC
has been criticsed for failing to cut rates quick enough
but its concern is that once inflation gets out, it's very
difficult to contain. Inflation of 5%, without tight monetary
policy, soon leads to 6%, 7% and upwards.
worst-case scenario, the recession is deep and long. Then
deflation becomes the big fear. That's when the bank rate
would need to come down below the 2% that most economists
predict for 2009.
In March, we
reported that dramatic US rate cuts could be on the cards
as the slump began to hint at similarities with the Japanese
banking bust of 1990.
happened in Japan?
Japan, the star
of the post-war global economy, entered a long-term decline
in 1990, frequently dipping into recession, until 2005.
Both share and house prices fell over that period as Japanese
workers refused to spend in the face of falling prices in
the shops – a deflationary spiral.
authorities were accused of being slow to act. But by the
late 1990s, the Bank of Japan had made its last roll of
the fiscal dice and cut interest rates to zero. The bank
rate briefly ticked up in 2000 but was swiftly returned
to 0% when the dotcom bubble burst. It remained there until
a brief economic recovery in 2005. That has since petered
out and rates are now at 0.5% and will probably be cut again.
it affect mortgages and savings?
deals are linked to the BoE bank rate, following it up and
down. However, lenders shrewdly add a 'collar' clause in
the smallprint. For instance, Nationwide tracker mortgages
will not go lower than 2.75%. Read the latest advice on
mortgage trackers. Mortgages linked to the standard variable
rate and the price of new fixed deals is more dependent
on interbank lending, which has been artficially high throughout
the credit crunch: it is what defines the credit crunch.
So unless Libor falls, new mortgage pricing will not follow
the bank rate down: Libor latest. The same applies for credit
card and loan rates.
cash-strapped banks are still falling over themselves to
secure deposits. So, rates should hold up relatively well
against a falling bank rate, although they will still decline.
Update on 29 October: Following requests via reader comments,
This is Money's Alan O'Sullivan examines what a 0% bank
rate would mean for savings rates.