Page last updated at 16:50 GMT, Thursday, 6 November 2008

Q&A: Impact of the rate cut

Wallet with notes and cards
Will the rate cut help to revive the economy?

In normal times a big cut in interest rates would soon lead to cheaper mortgages and lower savings rates.

But things are not normal.

Mortgage lending has slumped to its lowest levels since the early 1970s.

The economy appears to be plunging head-long into a recession.

And the authorities are desperate to bail out the banking system.

So how much will people benefit from the Bank of England's shock decision?

Will my mortgage become cheaper?

Lenders were taken by surprise by the size of the cut in the Bank rate.

Whereas they had been limbering up to make a swift announcement after a widely expected cut of half or even one percentage point, they are now pondering their next move.

A reduction of some sort is likely for existing borrowers whose deals are not fixed.

There would be a huge public outcry if mortgage rates were not reduced to some extent, and the government would be most displeased.

People whose existing deals are linked to the Bank rate will see their mortgages costs fall automatically.

The interest rates on new mortgage deals will in most cases be lower too.

The question is, by how much will the cost of home loans come down?

One bank, Lloyds-TSB, said in advance it would pass on the whole of any bank rate reduction to customers on its standard variable rate, now down to 5%.

Other lenders may not be so generous because all lenders, banks and building societies, big and small, are very keen to increase the profitability of their mortgage lending.

They are facing a rise in arrears and repossessions - which are almost certain to become worse because of the recession.

And with house prices still falling fast they need to cushion themselves against growing losses on their mortgage lending.

Unless the generosity of Lloyds-TSB forces the others to follow, the chances of the whole one-and-a-half percentage point cut being passed on are small.

It is also important to note that many mortgages are funded by the cost of borrowing between banks, which has stayed stubbornly high.

Among them are fixed-rate deals, and trackers linked to Libor, which measures the cost of interbank lending.

Will saving rates be affected?

A cut in the Bank Rate from 4.5% to 3% amounts to a one-third reduction in interest.

Again, normally, that would soon feed into the rates for savers on their savings and deposit accounts.

But with the wholesale financial markets still log-jammed, banks and building societies are now desperate to keep the public saving with them to provide the funds that are then available to lend.

So, savers rates may come down a bit, but probably not by as much as the full one-and-a-half percentage point

What about small businesses?

Banks charge their business customers much more for running their accounts than they do their individual customers.

Not only are businesses likely to pay more, in the way of monthly account charges, for a business account, they are charged higher interest rates when they go into the red.

Recently there has been a spate of complaints, from small businesses in particular, that their banks have been jacking up their overdraft rates.

This is crucial for them as most small businesses rely on their bank overdrafts to tide them over from month to month.

The cut in Bank rate should apply some downward pressure on business account interest rates.

But again, with banks desperate to rebuild their profits and reserves, this may not amount to much.

Will the economy avoid recession?

It is the whole economy, not just selected groups of borrowers or savers, that the Bank of England is trying to help.

The economy seems to be slowing down rapidly and the Bank wants to apply the accelerator.

The authorities hope that lowering the general cost of borrowing will do just that.

And that should, in theory, mean that more employers stay in business than would otherwise have been the case.

And fewer people should end up losing their jobs than if interest rates had been kept at their previous higher level.

That is the theory.

However, some of our gloomiest economic forecasters point to the awful example of Japan in the 1990s, where it took many years for the economy to start growing again after falling into recession, despite the fact that official interest rates were cut to zero.

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