By the time you read this, the Monetary Policy Committee will probably have published its January decision on interest rates; so what I write is academic – but then they are unlikely to listen to ordinary people anyway.
That does not mean, however, that we should not express our opinions …
Who would a rate cut help?
Homebuyers – are unlikely to benefit from further rate cuts because banks cannot afford to pass on further cuts
pro-rata. After all, they need a more-or-less fixed amount to cover their operating costs and if their income falls, the proportion of this required to cover costs rises.
Businesses – are also unlikely to benefit for the same reason.
Savers – actually lose out every time rates are cut because they receive less interest; for pensioners this can be devastating. This is also important because when interest rates are low, people have less incentive to save. This means that banks have less money to lend and the credit crisis simply deepens. The recent proposal by David Cameron to make savings tax free could be of value, but will become more so as interest rates bounce back.
Sterling – is also likely to suffer more as interest rates fall, because less capital flows in to the UK. A weak pound only helps exporters if there is a strong manufacturing sector to benefit from it – and customers to purchase what we make. Unfortunately, the first is not the case and the latter is affected by a global slowdown. What is more, the raw materials we import to manufacture goods are more expensive, the weaker the pound.
Overall, I believe the economy is unlikely to benefit from lower interest rates.
Why make a cut then?
If a cut is made – which at the time of writing seems more likely than not – we have to ask ourselves what the real motivators will be. It is certainly to be hoped that this is not simply to create a headline about ‘historically low interest rates’ that would be irresponsible in the extreme.
What is more likely is that they simply do not know what else to do. Interest rates as managed by the MPC are a ‘one-shot-gun’; they may, perhaps, have helped to keep inflation in check over the past decade – which is all that was asked of the Bank. But in the wider economy, there are other challenges, which this single tool cannot affect sufficiently.
What should they do?
In my view, one solution would be to increase the supply of credit to businesses – more, perhaps than to individuals, because stronger businesses will help the economy and reduce the rate of job losses. How this is achieved will be a matter for more skilled minds, but several options have been suggested including the government underwriting commercial lending, so that banks can lend responsibly without fear of default. This need no cost the taxpayer anything, because if it works, there will be no defaults and if it does not, we are already in a deep mess!
An alternative is for the Bank of England to start lending directly at ‘base rate plus’. This, however, has practical difficulties and is unlikely to be possible. Mind you, it would make the high street banks, who I still believe are to blame for the main problems, think.
If you are wondering what to do, about your
investments and
retirement planning,
contact Robert Bruce Associates for individual assistance.
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