- The bank of England doesn't control interest rates in the economy. It only controls the base rate (the rate at which commercial banks need to borrow from Bank of England.)
- The Bank of England hope that changing base rates will affect all interest rates, but, often this doesn't happen.
- The libor rate is the interbank lending rate and is important for determining actual commercial rates.
In the boom years of 2006-07, the mortgage industry became very competitive. Banks cut their profit margins in a bid to attract custom. Banks offered a wide range of mortgages to attract new customers - the 100% mortgages, mortgages 5 times salary e.t.c. By the end of 2007, the margin between bank base rates and commercial bank lending rates was at an all time low. But, banks had overstretched themselves. By lending too freely, banks like the Northern Rock and HBOS had left themselves open to liquidity problems when conditions deteriorated.
- What banks are trying to do now, is to effectively 'clean up their mess' They want to attract savings and reduce their lending to improve their balance sheets.
- This need to improve their balance sheets is even more important with the drastic decline in house prices which is leaving many homeowners with negative equity and making banks more vulnerable to repossession.
However, bear in mind
1. Banks can reduce their standard variable rates but still increase their profit margins. (basically there will be less 'special offers on mortgages' see: how banks will avoid making mortgages cheaper.
2. Politicians are not calling for a return to 100% mortgages and lending 7 times income, just reducing interest payments for those with existing mortgages - this will help avoid mortgage defaults.
3. The libor interbank lending rate is falling to 4.5%, making it harder for banks to avoid cutting rates. (although the gap is still high at 150 base points)
4. In 2009, Lower interest rates will not fuel an inflationary boom in house prices. Lower interest rates will merely help to stabilise falling house prices. When the housing market and economy recovers, of course these interest rate cuts may need to be reversed.
5. The gap between base rates and bank rates is now the biggest since the second world war. Telegraph