Interest rates slashed to record low of 1%

Published on Thursday 5 February 2009 12:07

THE Bank of England sent interest rates tumbling further to a new historic low of 1% today.

Rate-setters cut borrowing costs from 1.5% – the lowest since the Bank was founded in 1694 – as they attempt to combat a worsening downturn.

Today's Monetary Policy Committee (MPC) decision – the first since the UK's recession was officially confirmed – continues the record-breaking run for lower rates.

It also follows International Monetary Fund (IMF) predictions that Britain will suffer more than any other advanced nation in the worst global recession since the Second World War.

The Bank has cut interest rates dramatically – from 5% last October – as it tries to offer relief to borrowers and businesses.

But the rate reductions have been a savage blow to savers, and many mortgage customers have been warned not to expect lenders to pass on the cut in full.

In a statement accompanying the decision, the Bank said the global economy was in the throes of "a severe and synchronised downturn".

"Business and household sentiment in many countries has deteriorated. The weakness of the global banking and financial system means that the supply of credit remains constrained...

"Credit conditions faced by companies and households have tightened further. The underlying picture for consumer spending appears weak," it said.

The Bank said previous rate cuts would eventually have a "significant impact" on aiding the economy, alongside the current weakness of the pound.

But until these feed through, there is "a substantial risk" of undershooting its 2% inflation target with interest rates at 1.5%, it said.

The decision comes amid rising unemployment totals, with thousands of jobs being shed across the UK each week. January's figures showed jobless totals jumped by 131,000 in the three months to November to 1.92 million, the highest figure for more than a decade.

The rate cut was welcomed by business groups, which have campaigned for ever lower borrowing costs to stimulate lending.

Ian McCafferty, chief economic adviser to the CBI business group, said: "This drop in rates should support business confidence and, when added to recent cuts of the past couple of months and the fall in the pound, provides a very significant stimulus to the ailing economy.

"But at these very low levels of interest rates, and with the credit mechanism still impaired, it is vital that the Bank swiftly supplements today's move with direct intervention in the corporate lending markets."

But this week the Building Societies Association (BSA) urged the Bank to leave rates unchanged over fears that another cut would further hit savers, who have seen returns dive 75% in recent months.

The majority of banks and building societies have slashed savings rates, by up to one percentage point in some cases, although many have failed to pass on the proceeds of January's cut to 1.5% to borrowers on their standard variable rates (SVR).

There is better news for the majority of customers with tracker mortgages, as these will automatically fall in line with the cut today.

Around 300,000 customers with these deals will not benefit from the cut, as so-called collars have already kicked in on their loans, so the rate they pay cannot fall any further.

As rates edge closer to zero, economists predict the Bank will resort to more unorthodox measures in coming months to combat the UK recession.

The Institute of Directors' chief economist, Graeme Leach, said: "The half-point cut means we're getting close to the last hurrah for interest rates."

The Government's second bank rescue plan included a new 50 billion fund created for the Bank to use to buy up private sector assets to free up lending and kick-start the economy.

The MPC could also ask for powers to tap into the fund as it strives to combat deflation.

This has raised the prospect of so-called quantitative easing – increasing the supply of money in the economy to buy assets from banks.

Although the Bank's new powers do not yet extend to quantitative easing, governor Mervyn King has said that policymakers might need to use "unconventional" methods to bring inflation back in line with the 2% target.

The official measure of inflation, the Consumer Prices Index (CPI), plunged by the biggest amount since records began in December, down from 4.1% to 3.1%. It is set to fall even further below target as recession bites and demand falls.

Notes from the MPC's previous meeting showed members considered leaving rates unchanged in January amid fears about the fall in the value of sterling and to allow previous measures to take effect.

But analysts believe recent news that the economy shrank by a shock 1.5% in the fourth quarter of last year – the biggest contraction in almost 30 years – left rate-cutters with little option but to cut rates again.

Policymakers also had access to the latest inflation forecasts, due to be published next week, which could have affected their decision.