Will the UK drop in base rate make any difference to the crisis?
The Bank of England's monetary policy committee met on 6th November 2008 and took the decision to drop the bank base rate by an incredible 1.5%. Not only has this never occurred before, but the last time the base rate sat as low as 3% in the United Kingdom was 1954.
But is this going to make any difference to the market as it stands? Unfortunately, in my professional opinion, the answer to that question is probably "no". It seems likely to me that most lenders are unable to compete and drop their interest rates by this 1.5%.It seems that the majority if not all of the lenders have failed to pass this reduction on to their clients and are holding their standard variable as it stands, regardless of the fact that his is now at least 6 months behind the times.
The main difficulty, not only in the UK but worldwide, is that although the banks have dropped their base rate, the cost of lending from bank to bank has stayed the same. The name used for the rate at which UK financers lend to each other is the LIBOR rate. This acronym stands for the London Inter-Bank Offer Rate. The LIBOR rate has come down very slightly over the last few months, but nothing like the way the base rate has plummeted, so money, although it seems cheaper, still costs almost the same.
The LIBOR rate is dictated by the willingness of the institutions to loan money to each other. Due to the onset of the credit crunch and the fact that the poor lending policies of the institutions have come to light, there has been an unwillingness to lend between the institutions and this has a knock on effect on the LIBOR. They all know about each other's shoddy lending policies of the past and, due to the down turn in the economy, they do not want to expose themselves any further.
The massive injection of capital which has been promised by the worlds different governments would surely ease the situation, I hear you say. I am sorry but this is not the case. Rumours have come to the fore that a stipulation of these injections is that there will be mandatory set lending percentage increases forced on the institutions over the coming year and with that in mind they are saving themselves for these. I don't know but what is clear is that there is very little money out there and that the rates are poor for any lending that is occurring.
In my opinion, what the decision of 6th November will do is up the confidence levels of the public. People will come to the natural conclusion that the lowering of base rates means there is light at the end of the tunnel. They will soon realise this isn't so when they see that their mortgage rates have not changed in line with the bank's new rate. The difference may be seen in commercial finance though. Most commercial rates are set at a level above the bank's base rate, so it may reach here.
Irrespective of that, a lot of commercial lenders have bumped up their over base rate level to preempt any new customers looking to borrow. Equally, some lenders have already withdrawn their base rate tracker level or increased it so as to eliminate any possible risk of losing more money. After such a huge single cut in rates, and looking at the action being taken, it makes you wonder if these lenders actually saw it coming!
So what effect will the drop actually have? In the short term, probably very little effect at all. Nevertheless, I would like to think that over the coming months we will see the positive effect trickle down bit by bit into the markets. If it doesn't reach Joe Public, and doesn't reach sooner rather than later, we may have to face the possibility of being in some very, very serious financial trouble indeed. Fingers crossed then!
But is this going to make any difference to the market as it stands? Unfortunately, in my professional opinion, the answer to that question is probably "no". It seems likely to me that most lenders are unable to compete and drop their interest rates by this 1.5%.It seems that the majority if not all of the lenders have failed to pass this reduction on to their clients and are holding their standard variable as it stands, regardless of the fact that his is now at least 6 months behind the times.
The main difficulty, not only in the UK but worldwide, is that although the banks have dropped their base rate, the cost of lending from bank to bank has stayed the same. The name used for the rate at which UK financers lend to each other is the LIBOR rate. This acronym stands for the London Inter-Bank Offer Rate. The LIBOR rate has come down very slightly over the last few months, but nothing like the way the base rate has plummeted, so money, although it seems cheaper, still costs almost the same.
The LIBOR rate is dictated by the willingness of the institutions to loan money to each other. Due to the onset of the credit crunch and the fact that the poor lending policies of the institutions have come to light, there has been an unwillingness to lend between the institutions and this has a knock on effect on the LIBOR. They all know about each other's shoddy lending policies of the past and, due to the down turn in the economy, they do not want to expose themselves any further.
The massive injection of capital which has been promised by the worlds different governments would surely ease the situation, I hear you say. I am sorry but this is not the case. Rumours have come to the fore that a stipulation of these injections is that there will be mandatory set lending percentage increases forced on the institutions over the coming year and with that in mind they are saving themselves for these. I don't know but what is clear is that there is very little money out there and that the rates are poor for any lending that is occurring.
In my opinion, what the decision of 6th November will do is up the confidence levels of the public. People will come to the natural conclusion that the lowering of base rates means there is light at the end of the tunnel. They will soon realise this isn't so when they see that their mortgage rates have not changed in line with the bank's new rate. The difference may be seen in commercial finance though. Most commercial rates are set at a level above the bank's base rate, so it may reach here.
Irrespective of that, a lot of commercial lenders have bumped up their over base rate level to preempt any new customers looking to borrow. Equally, some lenders have already withdrawn their base rate tracker level or increased it so as to eliminate any possible risk of losing more money. After such a huge single cut in rates, and looking at the action being taken, it makes you wonder if these lenders actually saw it coming!
So what effect will the drop actually have? In the short term, probably very little effect at all. Nevertheless, I would like to think that over the coming months we will see the positive effect trickle down bit by bit into the markets. If it doesn't reach Joe Public, and doesn't reach sooner rather than later, we may have to face the possibility of being in some very, very serious financial trouble indeed. Fingers crossed then!
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