Bank of England warns of further base rate reductions

The Bank of England has today suggested that interest rates in the UK will fall as low as required in order to ensure that the UK economy does not fall into a major slump. Historically the Bank of England has been one of the most conservative central banks in the world although if the indications are correct, the shackles are about to come off. There had even been some suggestions that interest rates could fall to near 0%!

This new move has thrown into doubt the direction of the UK economy and the reasons why the Bank of England seems prepared to take such radical steps in the short to medium term. The governor of the Bank recently suggested that the pending economic slowdown in UK will reach depths not seen for over 30 years. We are now in a situation which many economic analysts and banking experts have never seen the like of before and never thought they would. Radical action is required for radical times and in line with the UK government it seems as though we can expect some fairly surprising and innovative announcements over the next few months.

So why now?

Many people are asking questions as to why the Bank of England has chosen now to release what could turn out to be the most radical policies ever seen in the UK, with many suspecting the Bank is in possession of classified information detailing the seriousness of the ongoing slowdown in the country. This can be the only answer because of the historically conservative nature of the Bank of England in times gone by.

The property sector is the key to any recovery in the UK market and at the moment there is very little sign of either buyers returning to the market or mortgage lenders reducing their rates in line with base rates. Until we see some real movement in this area of the economy we could see more and more radical strategies and approaches coming from the depths of the Bank of England and the UK government.

Why the big concern?

After a period during which the Bank of England seemingly refused to accept that the UK was moving into recession it seems to be full steam ahead with regards to fighting “a recession” with whatever means are to hand. The first warning that the bank had major concerns was the 1.5% reduction in base rates which took 99% of observers and experts by surprise.

The major concern at the moment is a rise in supply and a reduction in demand which if left untreated could slide into a deflationary period for the UK economy. Deflation is the worst possible outcome for the UK economy, and will absolutely smash the property market, due to the fact that prices will be forced lower which would place more pressure on businesses to cut costs, which were then reduced demand further and see prices drop into it a serious deflationary spiral.

The hope is that by increasing funding available to both businesses and UK consumers (which is done by reducing finance costs, i.e. base rates) the Bank of England should be able to instigate a stabilisation of demand which should then meet the supply level before deflation is encountered.

As long as the UK banking sector plays ball at some stage, with the reduction in finance costs for both business and the UK consumer, will see demand return to all areas of business and most importantly the property market.

What is happening to the UK property market?

Every now and again we hear news that the UK property market looks like it is stabilising only to find out days later that demand has fallen further and prices are still very much on a downward spiral. Negative equity is becoming a serious issue for many in the UK and we are also seeing an increase in the number of repossessions, even though this appeared to be a situation which would be avoided in exchange for the substantial banking rescue package. Even though there has been demand from overseas investors for UK property, this has in no way replaced the historic substantial national demand which has been under pressure for some time.

It also appears that each time the banking sector promises to assist both first-time buyers and those looking to move again, we see subtle changes to mortgage offers and interest rates which are all in all give nothing back to the UK public. To give an example we saw many of the major mortgage lenders withdraw their tracker mortgages just prior to the last interest rate reduction only to reinstall them after the change in base rates.

However, using the Halifax as an example, we saw the margin above UK base rates rise from 1% to 2% in basic terms, which effectively doubles the profit on the deal. To add insult to injury there was also a marked increase in the level of deposit required to take up such an offer which has effectively barred many potential first time buyers from entering the market at this moment in time.

What next?

As the Bank of England has suggested, base rates will fall lower and lower until demand is injected back into the UK economy although we are highly likely to see a change in the government’s fiscal policy as well. Gordon Brown has already indicated we should see tax reductions in the short to medium term although one of his ministers also suggested that rates would have to rise in the long-term to pay for any short-term “relief”.

The much vaunted rescue package has been fully ingested into the market now and there has been very little impact in the short term. It is thought that a mixture of the rescue package, lower interest rates, changing fiscal policy and pressure on the banks to reduce their mortgage rates will at some stage kick in to the market.

The seriousness of the UK situation is fully reflected by the change in stance by the Bank of England which has historically been one of the most conservative central banks in the world. For Mervyn King to first admit the UK is moving headlong into recession and secondly to suggest that rates could fall substantially from just 3% should be more than enough warning to those who query that there is any serious danger of deflation or depression in the UK.

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