Our views

Reflections on base rate cut

Martin Cholwill, Senior Fund manager

4 August 2016

I am rather sceptical that the interest rate cut announced today will stimulate the economy, which I am assume is the intention given the downgrading of economic growth expectations.  I believe it is possible we may see some unintended consequences as a result of this.

Interest rates are already very close to zero and I think that lower rates, or indeed negative rates if it came to that, are a clear negative for banks and will not encourage more lending.  All other things being equal, net interest margins for banks will be squeezed as it will be difficult for them to pass on the full cut in interest rates to their savers and current account holders through lower interest rates, as many will already not be earning any interest on bank balances. Banks may try to protect their Net Interest Margin (NIM) in part through their mortgage and lending book, so perversely it could lead to higher, not lower interest rates for borrowers, where the market will bear it. As interest rates get close to zero, interest rate policy becomes an ever more ineffective policy tool in my opinion and fiscal measures are far more likely to stimulate the economy. 

Lower interest rates, and the buying of corporate bonds through quantitative easing (QE), could also have the unintended consequence of making pension fund deficits balloon even further. I believe this is unlikely to encourage those corporates to invest in job creating capex; in fact, it is far more likely to stimulate yet more cost cutting initiatives. 

The silver lining of the interest rate cut is that the yield on the stockmarket has become even more attractive in an income starved world and I am not surprised to see the stockmarket up on the announcement. 

The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice.