Page last updated at 18:14 GMT, Thursday, 6 November 2008

UK interest rates slashed to 3%

Interest rate graph

The Bank of England has made a shock one-and-a-half percentage point cut in UK interest rates to 3%, the lowest level since 1955.

The size of the cut - the most dramatic since 1981 - signals the Bank's concern the UK is heading for a long recession, the BBC's economics editor says.

Mortgage lenders are now under pressure to pass the cut on to borrowers.

But due to the unexpected size of the cut, most banks have not yet decided how much of it to pass on.

"I think it's essential that the banks do pass on the benefit of lower interest rates to people and to businesses," Chancellor Alistair Darling said.

"Banks need to understand that they need to help their customers."

'Bigger than expected'

The BBC's economics editor Hugh Pym said the Bank of England was clearly concerned about the possibility of a prolonged recession in the UK.

This was evident from the Bank's use of terms such as "very marked deterioration in the outlook" and "severe contraction", he said.

Didn't we the taxpayers bail out the banks? Weren't we told that in return the Treasury had demanded strict conditions?
Nick Robinson, BBC political editor

Shadow chancellor George Osborne said: "This is a shot in the arm for the economy, but it shows how sick the patient is."

Traders on the London market were also concerned about the message the cut conveyed. As a result, the FTSE 100 share index closed down 5.6%, or 255 points at 4,275.7.

The UK cut was followed by a less dramatic move from the European Central Bank, which lowered eurozone interest rates from 3.75% to 3.25%, to try to boost economic growth in the region.

What's more, the global financial body the IMF sharply revised down its forecasts for economic growth around the world in 2009.

It predicted that developed economies as a whole would contract next year for the first time since World War Two.

Mortgage fears

The hefty cut will automatically reduce monthly repayments for those with tracker deals that are linked to the Bank rate by about 134 on an average 150,000 mortgage.

Chancellor Alistair Darling calls for banks to take action

However, there have been concerns that a cut in the Bank of England's base rate might not be passed on to other borrowers.

Given the surprise level of the Bank rate cut, mortgage lenders will take their time to decide whether they will pass on cuts to standard variable rate (SVR)mortgage holders, which account for up to 10% of total home loans.

The major lenders said rates were "under review", however Lloyds TSB has promised to pass on the rate cut in full to its standard variable rate mortgage customers.

The group, which also lends through Cheltenham & Gloucester, said its SVR, currently 6.5%, would never be more than 2% above Bank of England base rate. Abbey has also passed on the cut in full to SVR customers.

Customers on fixed-rate deals - about 50% of the market - will see no change to their repayments until they come to the end of their current deal.

But major lenders have been withdrawing nearly all tracker rate deals for new borrowers as they wait to see how the industry reacts to the cut.

The cut is likely to hit savers who face a reduction in the interest rates they receive from their deposits.

'The right call'

The move has been broadly welcomed by business bodies and trade unions.

Pie chart showing proportions of UK mortgages that are fixed-rate, discounted or standard variable

Richard Lambert, CBI director-general, said: "This is a bold and welcome move by the Monetary Policy Committee, and achieves what the CBI had been calling for."

He added: "This cut should help to ease conditions in the credit markets, and allow banks to pass the benefits on to their customers."

The TUC's head of economics Adam Lent said the move was "the right call".

"It shows the Bank now understands that the problem is recession not inflation."

Meanwhile, the Institute of Directors (IoD) said interest rates could touch record lows of 2% or less by this time next year.

"The sooner we get interest rates down the less is the risk of a long and deep recession," said IoD chief economist Graeme Leach.

Manufacturing decline

The Bank of England's interest rate move came after a series of figures released this week provided further evidence that the UK economy is sliding towards recession.

New figures from the Halifax showed house prices fell by another 2.2% in October, pushing the drop in house prices to 13.7% over the past year.

Activity in the service sector, the backbone of the UK economy, shrank in October for the sixth month in a row.

According to an index compiled by the Chartered Institute of Purchase and Supply output from services was at its lowest level since its poll began in 1996.

Also, the Office for National Statistics said that manufacturing output fell for a seventh month in September - the longest run of monthly declines since 1980.

Manufacturing output fell by 0.8% in September, much worse than analysts' expectations, making output 2.3% lower than a year earlier, the sharpest decline since May 2003.

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