A quarter point cut is a good start

Ray Boulger of John Charcol, UK Independent Mortgage Adviser, comments on today’s decision by the Monetary Policy Committee (MPC) to cut Bank Rate by 0.25% to 5.5%.

“Although the CPI is likely to increase further in the short term the 3% upper limit doesn’t appear to be under threat. The greater threat is the impact on the world economy of the consequences of the credit and liquidity squeeze and today’s 0.25% cut is a sensible first step towards mitigating these problems in the UK. Further easing of monetary policy will be needed in the short term to avoid GDP falling too far next year.

“3 months Libor has been at least ½% above Bank Rate for the last 4 months and in addition there has also been a severe shortage of liquidity. As a result monetary policy has been much tighter than the MPC thought necessary. Even if 3 month Libor falls 0.25% to 6.4% as a result of this cut there will still be an exceptionally large spread between Bank Rate and Libor of 0.9% and thus further cuts in Bank Rate are likely to be needed just to bring market rates back down to the old official rate of 5.75%

“Furthermore the impact of this rate cut will be less than normal because many mortgage borrowers paying their lender’s Standard Variable Rate (SVR), or a discount based on it, are likely to face disappointment. Because of the unprecedented current wide spread between Bank Rate and 3 month Libor I don’t expect lenders to rush to pass on this cut and of those that do many will not pass on the full 0.25%.

“The longer the liquidity squeeze continues the more the MPC will have to cut the official rate just to bring market rates, i.e. Libor, down to the old official rate of 5.75%! Unless the Governor of the Bank of England accepts that we are now well past his “moral hazard” stage and starts pumping much more liquidity into the banking system it may prove necessary to cut Bank Rate below 5% just to generate a significant impact on market rates.”

So what should borrowers do now Ray?

“It is at times like this that trackers really prove their value and with more Bank Rate cuts expected a tracker mortgage rather than a discount off SVR or a fixed rate is likely to prove best value. Having said that swap rates have already fallen a long way from their recent peak only 5 months ago and so for borrowers who prefer payment certainty a fixed rate or capped tracker would be more appropriate. There is little difference in the initial pay rate of the best value trackers and the best fixed rates and also little difference in the rates for fixed rates of different terms – all are a little above Bank Rate. Because there is now such a huge range of arrangement fees, both flat rate and percentage based, it is absolutely vital to compare the true cost of deals, taking account of both the interest rate and the fees, regardless of whether the choice is for a tracker or a fixed rate.”