Bank of England could cut interest rates to zero

Bank of England headquarters on Threadneedle Street

The Bank of England could cut interest rates to zero to stimulate the economy, but has “no interest” in reducing them further.

Bank of England Governor Mark Carney confirmed the stance on 23 February, when speaking to the Treasury Committee. The Committee was taking evidence as part of its examination of the Bank’s February 2016 Inflation Report.

Global factors put the UK economy at risk

According to recent reports, the risk of the UK’s departure from the EU has caused the value of the sterling to fall. An “unforgiving global environment” has left the UK vulnerable, Bank officials say, and the MPC is prepared to act if the UK economy shows further signs of weakness.

Low unemployment and steady growth do not rule out an upward increase. But if another downturn were to occur, the Bank could respond by “cutting interest rates towards zero”. Negative interest rates are not on the agenda, however.

Mr Carney told MPs:

We have … no interest in negative interest rates. We have other options and would take very seriously the impact of negative interest rates on financial services and building societies especially.

Other policymakers have previously hinted at a rate cut

MPC members Andy Haldane and Gertjan Vlieghe, the latter of whom was also present at the Committee hearing on Monday, have both suggested that the Bank of England could cut rates further. In opposition to the governor’s views, they have also made the case for negative rates.

Mr Haldane, the Bank’s chief economist, outlined last September the arguments for cutting rates below zero. Giving a speech to the Portadown Chamber of Commerce in Northern Ireland, he even suggested the “radical and durable option” of abolishing physical currency.

In January, Mr Vlieghe told the London School of Economics that policymakers should have considered setting negative interest rates in 2008. He argued that households may have been able to deleverage more quickly, and that spending might have recovered sooner.

This isn’t the first time the Bank has contemplated more cuts

This time last year, in anticipation of deflation, the MPC contemplated similar measures. The February 2015 Inflation Report outlined the case for expanding the Bank’s quantitative easing (QE) program and cutting the base rate further.

But the UK did not experience persistent deflation. The base rate remained at 0.5%, and not a single MPC member voted to reduce it.

What could further cuts mean for mortgage rates generally?

The point of cutting interest rates is to increase lending. In ordinary economic conditions, mortgage rates would follow the base rate closely. But since the recession, the two have diverged.

The base rate is, in essence, the rate at which the Bank of England charges lenders to borrow funds from it. In theory, decreasing this rate should prompt lenders to pass the savings on to their customers.

But in 2008, commercial banks were highly illiquid. Their shortage of funds made them reluctant to lend, so although the base rate was falling, mortgage rates were not following.

Gap between base rates and bank notes

Mortgage rates have fallen more gradually as liquidity in the banking sector has improved, and a recovering mortgage market has invigorated competition for business. Evidence therefore suggests that economic conditions have had a more pronounced effect on mortgage rates than monetary policy.

Comment: Andrew Turner, Director of Commercial Trust

Andrew Turner CEO“Though a fall in the base rate might not impact borrowing costs directly, it is more likely to further erode the returns on traditional savings. This will make property more appealing to investors and individuals saving for retirement, who recent studies suggest have not been deterred from buy to let by recent government intervention.

“Meanwhile, the Bank of England might wish to return to the drawing board. Despite a range of measures, inflation has been below target for over two years.

“Monetary stimulus alone is evidently insufficient. The government should consider tangible fiscal stimulus, such as investing more state money into building homes for both investment and owner-occupation. This will help to stabilise the housing market and improve the lives of buyers, movers and renters alike.”

This information should not be interpreted as financial advice. Mortgage and loan rates are subject to change.