Why Have Rates Fallen So Quickly?
- Recession much deeper than anticipated.
- All sectors of the economy are being affected.
- Previous rate cuts are not having the desired effect in boosting demand. Usually cutting rates by 0.5% would have a big effect in boosting spending. But, we are entering a phenomenon known as a liquidity trap where lower rates have only a limited impact in boosting spending and investment.
- Housing market in decline.
- Inflationary pressures have fallen away. People expect inflation to fall sharply in the near future.
What Will Be the Effect of the rate cut?
- People on variable mortgages and loans, will see a fall in repayment costs. (though many borrowers are unlikely to receive the full rate cut.- because banks are trying to encourage saving rather than borrowing)
- The Pound may continue to weaken against the dollar (In US interest rates are already very low) But, with ECB expected to cut rates by same amount, the rate cut will not worsen the Pound against the Euro.
- It is unlikely to stop the fall in house prices. It is very cheap to get a mortgage. But, mortgages are being rationed by requiring a high deposit (which most people don't have). Therefore, mortgage availability will remain weak.
It is possible because rate cuts are unlikely to cause any inflation since the economy is so weak. Basically, rate cuts are not having much effect, therefore, the bank is trying much bigger rate cuts than usual to stimulate the economy. If inflation falls towards 0%, then inflation is possible.
Are rate cuts better than Fiscal Policy?
Rate cuts will hopefully stimulate spending, without the government having to borrow more. The problem is that the government feels monetary policy alone is insufficient to stimulate the economy.