BoE gives in to rate cut pressures

The Bank of England announced its first cut in the base rate for two years today, to 5.5%. But will the decision make any difference to the faltering housing market or tightening credit conditions?

The Bank of England gave in to pressure today and cut interest rates by a quarter point, from 5.75% to 5.5%. It is the first cut to the bank's base rate in two years.

The Bank's Monetary Policy Committee cited slowing growth and tightening credit market conditions in its statement, which was released at midday on Thursday.

This month's decision has been described as one of the hardest the Bank has ever had to make. With falling economic growth and house prices on the one hand, and rising inflation on the other, analysts had been mixed as to the likely outcome of this latest meeting.

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However, economic data released yesterday had intensified expectations of a cut. The Halifax revealed this week that house prices fell 1.1% in November, their third monthly fall in a row. And a Nationwide consumer confidence survey on the same day showed the largest monthly decline since the beginning of 2004.

This latest data prompted a FTSE rally yesterday and this morning on hopes that it would see the more dove-ish members of the MPC win out. However, the blue-chip index dipped following the announcement.

Will it make any difference?

The rate cut will be welcomed by many who hope that a housing crash may be averted but, as John Stepek argues in today's MoneyMorning (Why the Bank of England can't save the housing market), houses are overvalued, by any measure, so lower interest rates aren't going to prevent a crash. If the bank wanted to prevent sharp falls in house prices, it should have prevented the sharp rise in house prices.'

Moreover, it remains to be seen whether the higher base rate will have any impact on banks' willingness to lend to one another or to the consumer. Although the 0.25% cut should lower the average mortgage repayment by £30, this is only likely to be felt by those on a tracker.

As broker John Charcol tells The Guardian, the fact that market interest rates the rates at which banks lend to each other remain well above the base rate, means it's likely that the cut will not be passed on to those on variable rate mortgages.

Inflation threat remains

Moreover, the bank's decision not to tackle inflation could be storing up problems for the future. As consumers begin to feel the effect of rising food and fuel prices, the consumer price index has crept up above the government's 2% target to 2.1%.

On his Evanomics blog, the BBC's Evan Davis, points out that the small degree of inflation which has been allowed to creep into the economy could make it hard to manage the changes occurring' as the economy reaches a major turning point.

The MPC insisted that it would continue to monitor [inflation] carefully', but argued that slowing growth should reduce demand pressures, thereby bringing inflation back to target in the medium term.

However, some of the most important factors driving up the cost of these essentials lie far beyond the reach of the MPC. Oil may have come off the boil again having approached the $100 in the last few weeks, but in the long-term, the only way is up. What's more, a growing and increasingly wealthy global population means soft commodities are unlikely to cool any time soon either. (For more on what the rising cost of food means for you, see: The goose is getting fat: at far greater expense)

The reaction

Nonetheless, most commentators were approving of this month's rate cut. The Times's Gary Duncan applauded the MPC for making the right decision against a tricky backdrop'. He also predicted that further cuts will following due to the ongoing stress in the credit markets, adding that the first cut is the hardest'.

The Guardian's Larry Elliot also sympathised with the men and women of the MPC though reminds us that conditions have been incredibly benign over the ten years since the Bank's independence.

He adds that the fact that the Bank took the decision to make the cut sooner rather than later should remind us just how vulnerable the economy is to the events unfolding in the world's financial markets'.