Finance

Market Comment

With headline interest rates being reduced substancialy by the Bank of England to just 2.0%, a level last seen in the 1950's should this bode well for borrowers?

In the United Kingdom, business surveys have weakened further and suggest that the downturn has gathered pace. Consumer spending and business investment have stalled, while residential investment has continued to fall. Activity indicators in the rest of the world have also weakened, though the further depreciation in sterling should moderate the impact of weaker global growth on the United Kingdom. And a number of fiscal measures to boost near-term demand are in train, both in the United Kingdom and overseas. Despite the actions taken to raise bank capital, ease funding and improve liquidity, conditions in money and credit markets remain extremely difficult. The Committee noted that it was unlikely that a normal volume of lending would be restored without further measures.

CPI inflation decreased to 4.5% in October. Cost pressures have also eased. Commodity prices continued to fall back. Pay growth remained subdued. And measures of inflation expectations fell back sharply. CPI inflation is likely to continue to drop back as the contributions from retail energy and food prices decline. The direct effect of the temporary reduction in Value Added Tax will also lower CPI inflation through much of next year, with a corresponding increase in inflation in 2010.

In the November Inflation Report, the Committee’s projection for inflation showed a substantial risk of undershooting the 2% CPI inflation target in the medium term. The subsequent decline in market interest rates and the further depreciation in sterling have raised the profile for inflation since then. But the weaker outlook for activity in the near term and the further falls in commodity prices have lowered that profile. Although the temporary reduction in Value Added Tax will lead to some volatility in inflation over the next two years, the new fiscal plans are unlikely to have a significant effect on inflation beyond that horizon.

At its December meeting, the Committee judged that, at the existing level of Bank Rate and looking through the volatility in inflation associated with the movements in Value Added Tax, there remained a substantial risk of undershooting the 2% CPI inflation target in the medium term. Accordingly, the Committee determined that a further reduction in Bank Rate of 1.0 percentage points to 2.0% was necessary in order to meet the target in the medium term.

The minutes of the Bank Of England Monetory Policy meeting will be published at 9.30am on Wednesday 17 December.

Currently leanders have appeared cautious in passing on interest rate cuts to borrowers and have needed a push to pass on all of the rate cut available. The Libor Rate has remained high with the key three-month sterling Libor rate starting the year marginally above 5.5% - broadly equal to the bank rate. It then climbed higher as the extent of the credit crunch emerged. It peaked at 6% in early April, despite the bank rate falling to 5% by that month, and then drifted down throughout the summer to a low of 5.7% on 12 September. A dramatic worsening of the crisis sent it up to 6.3% on 30 September (a 130-point gap with the bank rate). It has since plunged to factor in a fall in the bank rate from 4.5% to 2% but remains substantially higher than the bank rate.

For savers interest rate cuts at first sight are bad news as income returns fall from the sum on deposit. On closer analysis with inflation levels flat or even the possability of deflation then even a 1-2% return on investment income is very good. With the principle capital sum preserved and interest accumulating the buy power of your pound becomes stronger in a deflationary market.

Interest rates for borrowers have dropped but not as far as the headline bank rate, it would appear that we may be in for a period of low interest rates for the next year or so and this could represent an opportunity to borrow at historic low rates. Those with good credit ratings and good credit history should take advantage and explore the opportunities raised by these historic low rates. Pressure is mounting on car manufacturers to move product in the face of declining demand and as a result there are some excellent credit offers around from lenders with low fixed rate loans and HP agreements.

Borrowing is still available to many people even in the current climate, with carefull planning and use finance can be a powerful tool to assist you in your purchase. Even if you have cash to purchase a vehicle, leaving your money on deposit could possible be an advantage. Firstly you retain your capital sum and although the rate of interest payable on your borrowing is likely to be higher than that paid in interest from the sum on deposit, the real cost to you may be much less than you may have considered. For example if you were able to borrow £10K at a rate of 7% and you received 3% interest on savings of £10K then the offset borrowing cost is just 4% while still preserving your original capital sum.