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The Bank of England has cut borrowing costs for the first time since 2009, in a bid to stimulate the UK economy following the Brexit vote and the resulting drop in business and consumer confidence.
The 0.25 per cent cut was accompanied by a decision to expand the quantitative easing plan by up to £70bn, including a new plan to buy corporate bonds.
Stock markets have reacted warmly, with the FTSE 100 index up 0.1 per cent while the pound has fallen 1.5 per cent against the dollar to $1.31.
The decision has ramifications that stretch beyond financial markets and all the way into your bank account, however. For anyone with investments, a pension, personal loans, savings or a mortgage, here is what you need to know:
Millions of mortgage borrowers will be hoping their monthly repayments will fall as a result of the 0.25-point base rate cut — assuming their lender passes it on.
Of the 11.1m UK mortgage borrowers, about half are on floating rate deals, including a lender’s standard variable rate (SVR) and discounted variable rates. For the 1.5m borrowers on tracker loans, which pledge to rise and fall with the base rate, changes usually take effect from the following month.
If a lender decides to reflect a base rate change in its SVR — which is by no means certain — this usually takes immediate effect for new customers and at the start of the following month for existing borrowers.
How much will borrowers save? This will depend on factors including the drop in rates the lender chooses to pass on, the term length of their loan, and any lower limits on interest rate cuts set by lenders.
But someone with a mortgage of £150,000 repayable over 25 years at an interest rate of 2.86 per cent before the cut (the average for those on variable rates) will see a saving of just under £20 on a monthly repayment of £706, according to calculations by the Council of Mortgage Lenders, the industry body.
In the short term, fixed-rate borrowers will be unaffected by the base rate cut. However, lenders may feel able to sweeten deals — already at record-breaking lows— for those switching deals or first-time buyers.
Fionnuala Earley, chief economist at estate agency Countrywide, argued many high street lenders will, nonetheless, find it difficult to pass on the rate cut. “Most have to take care of savers and will be unable to shave much more off savings rates. Passing on any rate cut on mortgages would then just reduce already squeezed margins.”
Instead, she said, the bigger impact on the housing market will come from the economy’s performance over the coming months “and it’s still too soon to say how that will play out”.
Savings and personal loans
It has been tough to be a cash saver since the credit crunch. Since October 2008, Hargreaves Lansdown estimates savers have lost out on £160bn in interest on their cash accounts (compared to the interest rate they were receiving in October 2008).
Today’s rate cut may not make things too much worse for depositors, in the context of the incredibly poor returns they have become used to getting since interest rates were cut to 0.5 per cent in March 2009.
The average instant-access account on the high street is paying just 0.55 per cent, according to Moneyfacts, and the optimistic view is that they may not fall too much further, as today’s rate cut was expected by banks and priced in.
The real question for savers is whether to try to get higher rates by putting money with the less conventional lenders who occupy positions at the top of best buy tables. Relatively high payers include Swedish bank Ikano and a savings bank linked to French carmaker Renault as well as sharia-compliant accounts.
The rates on Islamic accounts are high but not fixed, because under Islamic law they do not pay interest but a share of the banks’ profits, which can fluctuate. The Swedish and French governments guarantee they will protect deposits in the event of a bank default up to €100,000.
Andrew Hagger, the independent bank analyst, says that seems safe, although it may take depositors longer to get their cash back than under the equivalent British scheme. The risk is “perhaps a one or two-month administrative delay”, he estimates, while cautioning that this has never been tested.
The yields on 10-year British government bonds fell immediately after the decision from 0.8 per cent to 0.67 per cent, which was a fresh record low. This is bad news for pensioners who are looking to exchange the money in their retirement pot for an annuity — products that provide a guaranteed income for life at a fixed percentage of the amount of money that has been saved.
Annuity rates are underpinned by gilt yields, and had already fallen sharply in the run-up to this Bank of England decision. The best open market annuity rate for a 65-year-old has fallen 3.6 per cent, according to Hargreaves Lansdown.
“The further cut in interest rates means now is probably the worst time ever to be making a retirement decision, with those buying an annuity today locking in to super-low returns for life,” said Steven Cameron, pensions director at Aegon, a provider.
The Bank’s decision will be also be painful for thousands of company pension schemes, which had been lobbying for a rethink of QE and urged for no further rate cut.
“We have now seen long-term interest rates fall markedly in the last few weeks, with 10 year government bond yields now well below 1 per cent,” said Charles Cowling, director, JLT Employee Benefits.
“This has caused pension scheme deficits to soar from already record highs to levels which for some could be catastrophic.”
What are the professionals who manage our money saying?
Brokers are seeing a hunt for income, with retail investors “choosing stocks that may not have the best earnings outlook but are paying dividends that look high relative to their share prices and the wider market”, said Russ Mould, investment director of retail stockbroker AJ Bell. Ahead of the interest rate announcement, investors were actively dealing in shares of UK banks, such as Lloyds and Barclays, which have relatively high dividend yields, Mr Mould said.
There was also high interest in oil stocks BP and Shell, which have dividend yields of about 7 per cent. Doubts linger about these companies’ profits in face of lingering low oil prices, but dividends pay out in US dollars which is seen as a hedge against further sterling weakness. The FTSE All-share dividend yield is about 3.6 per cent.
“The rate decision is going to heap further pain on cash savers and will not be good news for anyone who was contemplating an annuity purchase in the near future given gilts yields are already decimated,” said Jason Hollands, managing director at Tilney Bestinvest.
“The continuation of highly accommodative monetary policy should, however, prove supportive of riskier assets like shares and bonds, as investors search out higher yields. The recent weakness in sterling also provides some additional comfort in the near term, as it makes UK assets look more attractive to overseas investors, with the potential for a pick-up in M&A. However, at some point this artificial support to shares will have to unwind.”
Reporting by Naomi Rovnick, James Pickford, Josephine Cumbo, Aime Williams and Claer Barrett