Half per cent interest rates for longer?

"It is perfectly possible that, as time moves on, the right thing to do will be to keep the Bank Rate at ½ per cent even when unemployment has dropped below our seven per cent threshold," said Martin Weale, a member of the Bank of England's rate setting committee, the MPC.

He was trying to explain the Bank's interest rate policy to A Level students this afternoon: no easy task!

It adds to the Bank governor, Mark Carney's statement this week that:

“One can imagine a scenario where the unemployment threshold is reached, and that the best policy choice for the Monetary Policy Committee in that period of time is to keep rates at current levels, because the trade-off between output and inflation is attractive because we can keep inflation on target and can grow the economy further.”

All this is in the context of Forward Guidance, the Bank's attempt to give us fair warning about when it might raise interest rates. The threshold for considering a rate hike, we had been told, was a fall in unemployment to 7% of the workforce.

Despite acknowledging that the economy is recovering much fast than the Bank of England expected, they clearly want to keep us anchored to the view that they might stick to rock bottom rates if they see fit.

Will low unemployment trigger higher interest rates?

So this is an interesting point arising from the evidence Mark Carney is giving to the Treasury Select Committee. If unemployment drops to his threshold of 7%, does that automatically mean interest rates will be pushed up by the Bank's Monetary Policy Committee?

Perhaps not.

Because he's told them: "The 7 per cent threshold is a staging post. When we get there we have to evaluate what has happened to productivity, what are the broader labour market indicators."

On the one hand the Bank is saying it will take 3 years to get down to 7%. On the other, City econimiosts are saying the threshold might be reached in just a year or two.

But the MPC does have to move as soon as the threshold is reached. Carney has reiterated that 7% is the point at which the " MPC will consider tightening".

No further interest rate cut

The Bank of England's interest rate setting body, the Monetary Policy Committee, has ruled out a further cut in the Bank's base rate "in the foreseeable future".

This is from the minutes of the latest MPC meeting:

"37 The Committee also discussed the likely effectiveness of reducing Bank Rate to below 0.5%.Over the past few months, Bank staff had consulted with the FSA and the Building Societies Association on the possible consequences.  In the light of that, the Committee had re-examined in detail the desirability of such an option.  While it would be beneficial for some existing borrowers, there were concerns that a cut in Bank Rate might prove counterproductive for aggregate demand as a whole.  Staff analysis had concluded that a further cut in Bank Rate would be likely to cause a reduction in the profitability of some lenders, especially building societies, because of the prevalence of loans with interest terms contractually or closely linked to Bank Rate.  That would weaken their balance sheets and they might have to respond by increasing other loan rates or restricting lending. Viewed against the backdrop of the Funding for Lending Scheme (FLS), and the potential for building societies to play a material role in increasing lending, the Committee judged that it was unlikely to wish to reduce Bank Rate in the foreseeable future."

Thanks to Save Our Savers for pointing this out...

Cut in Bank Rate "under review"

The country's benchmark interest rate is "under review", after the Bank of England's Monetary Policy Committee (MPC) considered cutting it from the current historic low of 0.5%.

Nothing is happening for "the present time", but it is significant that the Bank has shifted from its previous view that a further cut in rates, recently suggested by the IMF, could backfire.

It's worrying news for savers, who are already suffering from very low rates on the nest eggs - but potentially helpful for millions of homeowners on tracker mortgages (which track Bank rate), who would see a cut in monthly payments.

Here's the meat of what the MPC discussed during its meeting on 6-7th June:

"In March 2009, the Committee had judged that a reduction in Bank Rate below 0.5% could have counterproductive consequences, in particular constraining some banks’ and building societies’ ability to lend.

Lenders were, in practice, unable to reduce deposit rates below zero.  But they had assets – primarily mortgages – with interest payments contractually linked to Bank Rate. Consequently, a reduction of Bank Rate below 0.5% might squeeze some lenders’ interest margins to such an extent that they became even less able to extend new credit.

On the one hand, there was some evidence that the proportion of outstanding mortgages contractually linked to Bank Rate had increased since early 2009, as a number of borrowers’ fixed rate deals had expired and they had moved to paying pre-set rates linked to Bank Rate.

On the other hand, since early 2009, retail deposit rates had increased somewhat.

So it was possible that lenders had greater scope than before to absorb a reduction in Bank Rate by cutting deposit rates without adverse cash-flow onsequences.  The extent to which this would be possible would depend on whether other funding costs also fell in line with Bank Rate.  In addition to this, it was possible that, were interest rates to fall further, the functioning of the money markets would become impaired.

Overall, the Committee judged that, at the present time, a further reduction in Bank Rate would not have any advantages over an expansion of the asset purchase programme, though it would keep the position under review."

If the Bank cuts rates...

It seems a long shot that the Bank of England would cut its base rate by 0.25% today, something the IMF suggested last month would be a helpful move. A reduction would leave the rate at a new record low of 0.25%.

But if it did, who would be affected?

Mortgage borrowers would feel the most immediate impact.

Around 2.5m households are likely to be on base rate trackers. That means their mortgage payments are tied to Bank base rate and go up or down as the rate moves.

In addition, at least a million are on a special form of Standard Variable Rate which would change. Their interest rates can't be more than 2% higher than base rate. Since they're at the maximum level already, a cut today would mean a cut in their payments.

So between 3.5m and 4m households could gain. A typical repayment mortgage of just over £110,000 would be £14.84 cheaper a month after a 0.25% reduction.

Other people on SVR would have to wait to see if they were affected, possibly not, while the large numbers on fixed rates wouldn't see any benefit.

What about savers? Their fear is that returns would dwindle even further.

Some banks would be likely to use a base rate cut as an excuse for lowering rates. However, the linkage is much less clear.

The current best savings rates of around 3% for an instant access account are kept up by desperation on the part of lenders to raise cash to lend out as mortgages.

Banks and building societies are cutting back lending because it's still tricky to raise the cash from international financial markets - savers are the only solid alternative.

In any case, those 3% accounts are only offered as a lure to bring in new deposits. The average interest rate is 0.22% for instant access savings at bank branches and 0.66% for tax-free cash ISAs.

Those paltry rates aren't likely to change much, even if the Bank tries to make money cheaper.

Risk-averse jerks - the banks

One of the Bank of England's independent policy experts has suggested banks could be "risk-averse jerks"  for holding back on lending to smaller businesses.

And he added that there were even more significant "fundamental" problems in their attitude to lending to businesses with productive ideas.

Adam Posen is a US economist who sits on the Bank's Monetary Policy Committee, which votes every month on whether to change the level of interest rates.

He said on BBC Radio 5Live that UK banks were not doing enough to support the real economy.

"How much of that is because they are reluctant, risk averse jerks and how much because there is something more fundamental at work - I think it's as much fundamental if not more so," he explained.

He said that cutbacks in lending to small, medium and new businesses had been "tremendous".

And Mr Posen commented that banks were "choosing to lend to roll over debts to large borrowers...but they're not issuing new loans to new borrowers."

Interest rates - what to expect

How are our finances going to be affected by the huge shift in interest rate expectations?

The prospect of a rise in interest rates has receded into the far distance.

Back in March, those all-seeing City economists were predicting, confidently, that the Bank of England's base rate was set to rise, with the first hike pencilled in for May.

Some even thought that the Bank's Monetary Policy committee would eschew quarter-point hikes and plump for a half-point jump to 1%.

Three of the MPC's nine members had already voted for an increase in February, they were so worried about inflation.

Come April and the predicted date for a rise was pushed back to August, then to November.

And today we hear that the MPC voted 9-0 against a rise.

More economists are suggesting that interest rates will stay where they are until 2013. That is so far ahead that it is hard to say what the situation will look like by then.

It is an intensely gloomy situation for people who rely on savings interest to prop up their incomes. Although headline savings rates are around 3% and fixed rates are higher, the average being earned from a Cash ISA is just 0.5%, uncannily close to Bank base rate.

Don't expect that to change much.

The conventional wisdom is that low rates are great news for mortgage borrowers. The large proportion of households on variable mortgage rates can breathe a sigh of relief that their payments won't be going up soon.

On the other hand, homebuyers face a tricky judgement. Should they choose a cheap variable (or tracker) rate, on the grounds that a rate rise could be a long way off?

Or should they choose the security of a fixed rate, knowing that for a period of 5 years, say, their payments will not change? Given the outlook for rates in general, new fixed rates could be forced down.

There is no easy answer. As you have seen, forecasts of future interest rates can shift wildly from month to month.

Savers desperate for rate rise

A group of campaigners working on behalf of savers has called on the Bank of England's Monetary Policy Committee to raise interest rates to help pensioners and encourage saving.

Save Our Savers says a country without savings is a country without a future.

And it warns that those on fixed incomes, such as pensioners, are suffering terribly from the combination of extremely low interest rates and above target inflation.

The group has written to all nine members of the Monetary Policy Committee, who are expected to leave the Bank's base rate at its historic low of 0.5% after meeting today and tomorrow.

The letter complains that the real value of the nation's cash savings has fallen by £50 billion over the last 12 months as a result of high inflation and low rates.