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Could interest rates be cut even further?

Written by Sam Jones on 25 September 2015.

We note with interest that the Bank of England openly considering whether it should cut interest rates even further than 0.5%.

For years the speculation has been one way on when the Bank will eventually return rates to “normal” levels and increase from the rock bottom.

But now the Bank of England chief economist Andrew Haldane is warning a rate cut could be more appropriate to boost economic growth.

Traditionally interest rate rises are designed to fight inflation in an economy. They cut disposable and income and help keep prices on an even keel.

But the Office for National Statistics says UK inflation was 0% in August meaning a rate rise could create price falls and deflation, which is very damaging.

The ONS said inflation has fallen from July when it was still a very low 0.1%.

Instead of raising rates, Haldane suggests a more dovish approach could bring inflation closer to its 2% target.

Falling oil and food prices are driving down prices in the western world and the spectre of deflation haunts Europe.

While high inflation eats into people’s incomes, cuts spending power and harms economies, deflation is arguably much worse.

Deflation means falling prices meaning no one is willing to spend today if they can get it cheaper tomorrow.

Who would buy a car today for £10,000 if they know it will cost £9,500 in six months’ time. People will hold on to their cash and wait.

More significantly, businesses will hold on to their cash and stop investing in the future avenues of growth. Firms do not invest in things that will lose value as soon as they buy it.

That is the reality of deflation and it can produce a destructive cycle of economic problems that is difficult to escape from.

It is a disease that has infected the Japanese economy for 20 years. Booming in the 1980s, the Japanese have been hit with falling prices and can not create growth.

The US Federal Reserve held rates at 0-0.25% last week, meaning they have been at that level since 2008. This is what the Bank of England fears and it is fantastic news for mortgage borrowers.

We are delighted to see mortgage rates at record lows and the idea they can become even lower is great news for homebuyers and landlords.

Nobody should rely entirely on what they believe will happen to interest rates based on the global economy but look at their own circumstances.

Borrowers should speak to professional advisers and work out whether they would feel comfortable fixing their rate in an uncertain economic climate.

Or some may be able to cope financially with more variations and take out a tracker. Trackers can be great value if rates stay low but they can fluctuate from month to month if they start to rise.

We also believe rates are not the only test and borrowers should look at flexible deals that suit their needs if appropriate. Headline low rates are not always the best deal.

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