Three key reasons why a base rate cut might not be passed on

Oh, they are certainly getting a handle on this public relations malarkey round at the British Bankers Association.

Thursday’s UK rate cut has been followed up promptly with a new “factsheet” from the BBA, explaining “the importance of the Bank of England base rate and summarises the other factors influencing how banks and other financial businesses set their interest rates.”

Rough translation – “Don’t listen to Darling”

1. When it sets the official bank rate, the Bank of England considers the amount at which banks borrow from each other overnight. Central banks do not believe that they can control the level of interest rates for any longer periods. But banks set their interest rates with a view to how the market will look in the longer term, typically in three months’ time. Things might look very different from these two perspectives, particularly in times of uncertainty. Banks will need to factor in the likely level of interest rates in the future and will also be looking at other market indicators to assess what the economy might look like in the coming months. They will also consider the relative risk of lending to a particular customer.

2. There is also a general economic downturn. Consumers are reluctant to spend, companies are reluctant to invest and banks are more careful about who they lend to. They have to make informed choices about which companies and customers they believe will survive the downturn. The amount of credit that they have available is also curtailed, because, put simply, they cannot lend money they have not got. This is as true of other markets as it is of the UK: bank lending rates in the US and the eurozone are also still generally at a level well above their central bank rates.

3. There is a minimum interest level beyond which tracker mortgages cannot pass on base rate cuts. This will be detailed in your tracker mortgage agreement. This minimum interest rate (known as a “floor”) reflects the fact that it still costs lenders money to operate a mortgage, whatever is happening in the wider economy. These minimum levels are typically triggered only in exceptional circumstances, when the official bank rate falls significantly below its long-run average. The official bank rate is currently at its lowest rate for 50 years.

Related links:
Publications at the BBA

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