Base rate unlikely to fall below 0% as this could have adverse affect on mortgage lending

19 February 2009 / by Rachel Mason
Inflation targets are unlikely to be met solely by cutting the base rate further, according to the Bank of England's Monetary Policy Committee.

This month, the MPC unanimously voted to cut the base rate by a further 0.5 per cent, taking it down to one per cent, but warned that it is unlikely to fall below zero as this would be unlikely to fuel the economy.

"At very low rates of interest, the stimulus that a reduction in Bank Rate could provide was likely to be much reduced," said the Bank.

In fact, the MPC minutes revealed that members are concerned further cuts could actually drive the economy into deeper crisis due to the fact that mortgage lenders are already struggling to pass on the cuts and still make a profit.

"Indeed, there might even be a point at which further cuts in Bank Rate could have an adverse impact on the economy," said the Bank, "since banks and building societies maintained a spread between their deposit and lending rates to cover the costs of providing banking services and to make a return on capital."

It said that once deposit rates are at zero, banks may decide not to pass on cuts and that "would reduce the effectiveness of monetary policy."

The MPC also warned that if banks were to pass on further cuts, because, for example, they were contractually obliged to do so, their profits would fall and this might cause them to restrict their mortgage and other loan criteria further, which would have "potentially adverse consequences for the rest of the economy."

The MPC decided that as the scale of these effects remained uncertain, a large reduction in the Bank rate was still needed for February.

However, due to the fact that further cuts throughout the rest of the year are unlikely to inject sufficient stimulus, the Committee is resolved to the fact it will need to "use alternative policy instruments" to kick start the economy, including printing more money.

All nine members voted in favour of 'quantitative easing', or what non economists call "turning on the printing press," which is where the Bank buys up bonds either from banks or from the commercial sector to boost the supply of money in the economy.

According to reports, BoE governor Mervyn King has already asked chancellor Alistair Darling for the Government's permission, which suggests that the process could begin within days.

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