Some Good News from Britain?

11/10/2008 9:14 am EST


Chris Gilchrist

Editor, The IRS Report

Chris Gilchrist, editorial director of Everyinvestor, says falling interest rates could spur mortgage lending in the weak UK economy.

The Retail Prices Index (RPI) annual increase in September was 5%, up from 4.8% in August, thanks mainly to higher domestic energy prices. And for the first time in years, the Consumer Prices Index (CPI), the harmonized European measure of inflation, showed an even higher year-on-year rise of 5.2%.  This is because the CPI does not include housing costs, but falling house prices are (indirectly) reflected in the RPI.

As for the inflation outlook, most economists agree with the Bank of England that it will fall back to the 2% target over the next 18 to 24 months. And some are far more optimistic, talking about CPI inflation under 3% by next autumn. To a large extent, this is because of a stabilization of energy prices and an expected drop in food prices following a sizeable fall in the price of wheat and other crops.

Meanwhile, the credit crunch has already prompted a 0.5% cut in the Bank of England’s base rate from 5% to 4.5%, and [the Bank cut rates by another 1.5 percentage points last week, to 3%—Editor.]  

The good news is that the fall in the base rate and two-year swap rates means that fixed-rate mortgage costs are likely to drop sharply by next January. And the banks have all signed up to continue to provide mortgage lending to households at similar levels to 2007.

Meanwhile, the results of the government’s bank rescue package are starting to work through the money markets, and an inevitable consequence—indeed one on which the success of the plan depends—will be a reduction in the interbank rates at which banks lend to each other.

It is because interbank rates are high that banks have bid up the rates for High Street deposits to their current levels, which are well above the Bank of England base rate. As interbank rates come down, banks will not need to pay such high rates, so if the base rate is 3% next year, you can expect High Street savings rates to be 4% at the very most. But we’re unlikely to see significant cuts in lenders’ SVRs (standard variable rates) until the New Year.

But at least as far as both inflation and mortgage interest rates are concerned, the outlook is now far more positive than it was a few months ago.

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