At midday the markets were caught off-guard as the two-day meeting of the Bank of England’s Monetary Policy Committee concluded by surprising everyone with a massive 1.5 percentage point cut in the Base Rate, slashing it to just 3.0pc, the lowest level since 1955.
With recession deepening and house prices still in free fall, they are now down nearly 20% in RPI-adjusted terms since their peak last year, there will be a hope that such a spectacular cut can put a floor under the economy, although nothing can be done about the damage already inflicted by not acting sooner.
However, the key to any cut will be how fast it is passed on to the consumer. It is the cost which banks charge each other which is paramount here and that is the LIBOR rate. Having been as low as just 16bp before the Credit Crunch, recently the difference between the Base Rate and the 3-month LIBOR rate was up around 180bp. In the last couple of weeks 3-month LIBOR had fallen back to under the 120bp mark and it will be hoped that today’s decimation of the Base Rate will result in both the nominal and relative interbank rates coming down.
To put any floor under house prices, falling rates will also need to be matched by increased Loan-to-Value ratios for borrowers. Higher LTV ratios will be especially important given the needs of first-time-buyers and movers with negative equity.
It is highly unlikely that today’s shock-and-awe rate cut will lead to an immediate V-shaped bounce in house prices, but it could begin to provide a base on which prices could stabilise.
Realistically, prices need to fall another 10%-15% to encourage more buyers from the sidelines. It is important though that any continued declines in house prices are at a slowing rate. When prospective buyers notice that they will then begin to feel that a bottom is near. And that, combined with low interest rates and higher LTVs, will be what begins to get the housing market moving again.
Today’s decisive action by the MPC is hopefully the first step along that path.
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