Mortgage rates down but full effect of base rate cuts yet to be seen

25 February 2009 / by Rachael Stiles
The cost of mortgages has fallen but the full benefits of the recent dramatic fall in the base rate might not be seen for several months.

The full effects of the cut in interest rates from five per cent to one per cent in the space of five months might not be seen for some time, according to Andrew Sentance, member of the Bank of England's Monetary Policy Committee, but the mortgage market is already benefitting.

In a speech to the Institute of Economic Affairs at its annual state of the economy conference this week, Mr Sentance said that in normal times there is usually about a six to nine month delay from when the base rate is cut to when changes in interest rates and spending in the 'real economy' are seen.

Therefore, it is "too early yet for us to assess how far this relaxation in monetary policy is providing support for consumer spending and other elements of private sector demand." he said.

Now officially in a recession, the UK economy is expected to shrink 2.6 per cent as a whole this year, according to the February Consensus Forecast, and the Bank of England's outlook is even more cautious, predicting in its Inflation Report this month that GDP will fall about three per cent on average in 2009.

It has been 18 years since the UK saw a year of recession, and Mr Sentance noted that "The fact that we have to look back nearly two decades to find the last recession and three decades or more for its two predecessors inevitably makes it harder to put the experience of the current recession in perspective." he said.

The current downturn in the UK economy can be traced back to the global financial crisis in some way, he explained, such as the disruption in credit markets, and the restriction on lending which has limited access to various types of credit for both consumers and businesses.

The property market has experienced especially adverse effects as a result of the lack of available credit, he said, but this is "now being felt more widely across the economy as a whole as the downturn in lending affects consumer spending and investment."

Mr Sentance also suggested that further rate cuts could be on the cards in coming months, saying that "we should expect this relaxation of monetary policy to provide support to spending as we move through the year – and help offset some of the other negative recessionary pressures on demand and output."

While the wider economy has yet to feel the full extent of the rate cuts made by the Bank of England, they have already fed down to the mortgage market, he said.

The LIBOR – the rate at which banks lend to each other – has fallen from six per cent last autumn to around two per cent, allowing mortgage rates to come down for many borrowers, especially those on standard variable rate and tracker mortgages.

"While there were concerns late last year about whether borrowers would indeed benefit from lower interest rates," he added, "there is now much more evidence that firms and households are seeing lower borrowing costs."

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