UK interest rates stand at 0.5%
[ Posted March 6th, 2009 ]The interest rates in UK have been cut once again to their lowest level ever in a bid to resuscitate the British economy. In the past interest rates have been used by Bank of England as a brake or accelerator for the economy. For instance if the bank wants to make savings more attractive and debts more expensive, its going to increase the base rate. This will persuade people to save more and spend less and reduce inflation in order to slow down the economy. In contrast if interest rates are cut it encourages people to spend more and save less, and as a result the economy is going to get a boost.
The Bank of England uses interest rates as a tool to keep the UK economy on track by keeping a check on inflation. It ensures that inflation is kept around a healthy 2% mark which is set by the government. However, in these extra ordinary times when credit availability has become a novelty, this mechanism of increasing or lowering the base rate hasn’t worked. Due to toxic assets and loans which are unlikely to ever get repaid, the banks have become overly cautious. The banks have shown little enthusiasm for even trading with each other, let alone incur more consumer debt by lending to business or individuals.
Although the interest rates have been falling for the last 18 months but new buyers are still finding it impossible to get affordable mortgages. On top of all this, there is serious concern about the health of the British economy as banks have been nationalized and their credibility damaged beyond repair. The government has poured billions into the banking sector to ensure that banks do not collapse as this would be catastrophic for the economy as a whole.
The British government has given Bank of England £50 billion to buy toxic assets and mortgage debt as part of the 2nd bank bail out plan. This allows UK businesses for the first time to borrow directly from the central bank instead of going to debt riddled commercial banks. This also means that banks can offload their mortgages and other consumer debt from their balance sheet to Bank of England. The government hopes that this move will encourage banks to start lending and show more flexibility when people take out a mortgage or a loan.
Apart form the interest rates cut, the Bank of England has decided to print money. This money will be handed over to the troubled banks in return for their risky assets, but nobody knows if such a move will have its desired results. This procedure in the banking terms is called quantitative easing.
The MPC added ‘The committee recognised that the impact of such operations was both uncertain and subject to time lags’. Other countries have also used this model in the past to rescue their economy, for instance Germany tried this in 1920 and Zimbabwe in recent years but unfortunately both of them failed. This really is the last throw of the dice by the Bank of England, the aim is to make money so cheap that the banks start offering loans again.