Bank of England Cuts Interest Rate to 5%

The Bank of England announced a 25-basis point rate cut yesterday, taking the UK’s base interest rate down to 5%. This is the BoE’s third rate cut since December. The housing market there has been slow for some time, and the City is as nervous as Wall Street about financial instability. The rate cut suggests that the BoE is not panicking, but it realizes that the British economy is wobbling.

In theory, this will make it easier to get a mortgage in the UK and will, therefore, support housing prices. In actuality, though, it isn’t quite so simple. Many fixed-rate mortgages are priced not by the base lending rate but by longer-term money market rates. One of the bigger mortgage lenders, Nationwide, put its rates up on fixed-rate products by 0.12% to 0.32% from Friday. Meanwhile, another lender, Alliance & Leicester, raised rates across the board twice this week before the BoE’s move.

The fact is that when a lender’s balance sheet looks weak, or if there is a perception in the market that the financial system isn’t capable of absorbing much more in losses, the lending rate doesn’t much matter. The lender isn’t going to make very many loans other than to absolutely rock, solid borrowers. And even then, it is going to be very careful in how it makes those loans.

Analysts in the UK suggest that the size of the cut means the BoE thinks the economy is broadly in line with its expectations. If so, that would mean the BoE foresees GDP growth this year of 1.5% to 1.75%, with mild inflationary pressures and no recession. The Bank also believes that the inflation rate could top the government’s target of 2% per year, but expects it to be a brief piercing of the ceiling regardless of commodity prices.

And if it is wrong about the recession potential, the Bank of England has 5% to play with. It could make 19 cuts of 25 basis points each and still not be a zero. That’s a very comfortable cushion for policy makers. The Fed has less than half that to work with, much less room for maneuver. It also means that the American economy is in worse shape than Britain’s.

© Copyright 2008 by The Kensington Review, Jeff Myhre, PhD, Editor. No part of this publication may be reproduced without written consent. Produced using Fedora Linux.

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