ECB and BOE could cut Interest rates

31st July 2012

The potential for rate cuts is discussed here. The rate cuts could potentially have an impact in two main areas – corporate and consumer borrowing.

Consumer borrowing

In consumer borrowing, the most significant effect is likely to be seen on mortgage rates. To some extent this is happening. HSBC has launched its lowest ever mortgage rate – a 5-year fix at 2.99%. Lower interest rates would allow more mortgage providers to offer this kind of rate.

However, the HSBC rate is only open to the strongest borrowers with a deposit of 40%. As such, it will prompt some remortgaging at the margins, but is unlikely to open up a wall of capital to boost the economy. Recent figures suggest that mortgage approvals are still low: "Howard Archer, chief UK economist at IHS Global Insight, said the slump in approvals "indicates that underlying housing market activity is limited".

"Significantly, mortgage approvals are very low compared to long-term norms. June's level of 44,192 is only 51.1% of the average monthly level of 86,537 seen since 1993, while a level of 70,000-80,000 has in the past been considered consistent with stable house prices," he said."

The trend is still for consumers to deleverage rather than take on more debt, so to this extent lower interest rates are only likely to have a muted effect on consumer spending.

Corporate borrowing

The problems on the corporate side have been well-flagged. Specifically, either banks are not lending, or businesses don't want to borrow, depending on who is giving their version of events. There has even been a fear that a cut in rates could damage credit supply. Simon Ward, chief economist at Henderson says: "The MPC was previously concerned that this would damage credit supply by squeezing banks' net interest margins but the cheap funding offered through the Funding for Loans Scheme is now expected to have an offsetting impact."

In this Reuters video, luminaries such as Ben Bernanke and Jim Glassman, an economist at JP Morgan Chase suggest that there is a potential impact. Glassman says: "By driving interest rates down it drives down the cost of financing. It makes businesses spend. It makes businesses more willing to embark on the long term projects."

However, Mark Vitner, senior economist at Well Fargo, counters by suggesting that because businesses know that rates will remain lower for longer, they feel no urgency to borrow to make investments.

The jury is still out, therefore, on whether lower interest rates will have any impact at all on the economy. However, with no immediate inflationary pressures, policymakers are taking the gamble that it can't hurt. Investors should certainly expect no immediate effects from the move, if it happens at all.


More on Mindful Money:

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