UK interest rates
The Bank of England’s inflation report gives a strong indication that interest rates in the UK could fall to 0 – 0.25%. There is also an increasing likelyhood of quantitative easing – a policy of creating money to avoid the deflationary impact. (B of E report)
The UK is facing its deepest recession since the Second World War (Not for 100 years as a government minister Ed Balls suggested). GDP is forecast to decline by 4% this year, and there is a prospect for further falls if the global economy continues to decline. Combined with falling commodity prices, the high levels of spare capacity is leading to a significant fall in inflation. The Bank forecast inflation of 0.6% this year. If the economy fails to recover in 2010, we could be faced with deflation – something which could be very damaging for the economy.
What is Effect of 0% Interest Rates?
Those with variable mortgages, especially tracker mortgages will be facing very low payments. There is even prospect of some tracker mortgages with 1% off base rate having to pay mortgage holders! (I’m not sure whether banks can get out of that or not, it depends on fine print. Suffice to say when banks offered tracker mortgage deals of 1% of base rate they never anticipated 0% interest rates
Savers will face very limited returns. Savers will struggle to find accounts which offer a decent return. However, many banks are still looking to attract more deposits, so some accounts will offer significantly above the 0% base rate.
The good news for savers is that the fall in inflation will help increase the real interest rate. Currently we have negative interest rates (inflation is above base rates) but the fall in inflation will mean real interest rates will improve. This is good news for savers, though people tend to just concentrate on the nominal interest rate and not real interest rates.
Problems of 0% interest rates
- Banks may struggle to attract deposits. E.g. people keep more cash or buy gold. This could make less deposits available for new mortgages
- Banks may not pass rate cuts onto consumers. Monetary policy becomes ineffective.
- Quantitative easing is unknown territory. It could be inflationary in the long term. Though the threat of deflation could be damaging for UK economy.
The Bank of England will have to turn to quantitative easing soon, in my view. It simply cannot cover the losses of the major banks, so it needs to stop asset prices falling… if that requires inflation, I think that will be seen as the lesser of two evils.
According to MoneyFacts quoted in the Financial Times of Saturday, February 14th, falling rates of inflation have made for HIGHER real rates of interest for savers than even one year ago, when interest rates were very much higher!
Even zero rates – when UK houses are grossly overpriced relative to wages and to the declining jobs to support those wages – will not be sufficient to remedy the failure of continued payment on the overvalued principal.
I am quite sure the banks have a negative mortgage get-out clause in their small print, though it would be fabulous to be paid interest on debt, there would be a rush to get into as much debt as possible!! The US is already flirting with 0% interest.
The effects on the exchange rates of ‘quantitive easing’ have me worried, the firm I work for is a distributor of US and European goods…