What would happen if base rate fell to 0pc?

Posted in 'Personal Finance' by Neil Greenhill

25 May 2012

Presenting a report earlier this week on state of the UK economy, Christine Lagarde of the International Monetary Fund suggested that the Bank of England should adopt a 0% base rate to help the economy through the continuing euro crisis, in addition to more quantitative easing. The Bank of England has not yet reduced rates below the current historic low of 0.5% - but with recent figures suggesting that inflation is back under control, and with the economy still flagging, it’s possible that the Bank of England could take up her suggestion. Should that happen, will this have any real effect on you and your wallet?

All depends on your current financial fortunes. If you are a saver, then you may be left out of pocket. If you are a borrower, then there is a very remote possibility that you may see a small decrease in the cost of credit. No one can say for sure but it looks unlikely to benefit anyone by much at all.

If you are a saver, then it’s likely you’ll be hit yet again - this time with the real possibility of earning nothing back in return for depositing/risking your savings at a bank. You may have to look to more risky investments to get a good return on your money, or look to invest abroad.

As a borrower, you may not be any better off either. Credit cards have actually got more expensive since 2008 when the recession began - the base rate was 5.5 % back then and if a 5% drop in base rate has not led to lower interest rates, in fact they have increased. Frankly, it’s unlikely a further 0.5% will make any difference at all to the interest rates charged on cards or loans.

In theory, mortgages offer the greatest scope to benefit from a base rate change. If you are on an existing tracker mortgage then it is possible you will see a drop in your interest payments. But this isn't by any means a certainty - many mortgages may have a minimum interest rate written into the contract - for some home owners this may have already been reached and so the interest rate cut will not be passed on by the lender. You will need to check the terms of your mortgage to find this out should the base rate drop. We have also reported recently on moves by several mortgage lenders to increase interest rates despite stable and low bank base rates.

For those on a Standard Variable Rate mortgage (the in-house rate set by your lender) there may be a reprieve from the incremental increases of recent months but it is unlikely there will be a drop – on current form, lenders are far more likely to keep any benefit of a base rate cut for themselves, blaming increased costs of funding in the retail markets, and rising bad debt provisions.

If you believe base rate will fall to a new low, then if you are a first time buyer, a tracker mortgage may make sense – but be sure to check that there is no minimum interest rate in the terms and conditions that would effectively make your tracker a one-way arrangement, where you would be subject to interest rate increases, but have no chance of any decrease.

A base rate drop to 0% would, we think, have little or no effect on most of us. If you are looking to increase the amount you earn on your savings, or to reduce the cost of borrowing on your borrowings, it’s a much better bet to keep your eye on the marketplace and be prepared to move your savings or mortgage where possible to get the best deal.

Neil Greenhill is a Credit Analyst at Checkmyfile and has a degree in Law and Politics from Cardiff University. He is also an Associate Member of the Institute of Credit Management.