Interest rates cut to historic low – but will it have desired effect?

As interest rates fall to a historic low, Andy Walker looks at whether the Bank of England's latest measure to boost the economy will make a real difference to the economy and says that the government needs to act too. 

Andy Walker
05 August 2016

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UK economy

The Bank of England’s decision to cut interest rates to 0.25% from 0.5%, the first cut since 2009 and a historic low, has been made to try and boost an economy that has taken a significant negative hit in the wake of the Brexit vote at the end of June.

The rate cut is part of a package of measures to address the impact of the UK’s decision to leave the EU. Other steps being taken include pumping £60bn into the economy by buying government bonds, £10bn in buying corporate bonds and giving £100bn in funding to banks to help them pass on the base interest rate cut to the real economy.

It seems that further reductions in the base rate are on the agenda after Bank of England deputy governor, Ben Broadbent, told the BBC's Today programme this morning that there could be a further interest rate cut this year if needed. 

In cutting the rate to 0.25% on Thursday this week, the Bank of England had already hinted that rates could go lower if the economy worsens. Asked if there was a real prospect of another cut in rates this year, Broadbent replied: "Absolutely."

The Bank has acted after a series of economic surveys since the EU referendum, including on employment, the housing market and business confidence, had revealed a marked downturn.

Lowering interest rates should help the housebuilding sector as well as construction more generally as cheaper money means more affordable mortgages and an increase in confidence for investors.

Clearly though the Bank is taking a watching brief on developments hence its strong hint that interest rates might have to come down even further if the economy does not pick up. The danger is of course that savers feel more cautious about the future and this in turn leads to a further downturn which then leads to a dip in confidence across the board.

Clearly the Bank of England is taking a watching brief on developments hence its strong hint that interest rates might have to come down again even further if the economy does not pick up.

Bank of England governor, Mark Carney, has already warned this week that the economy would be likely to be 2.5% smaller in three years’ time than it would have been without Brexit and unemployment could be as much as 250,000 higher.

The government’s much vaunted recovery was already faltering before the Brexit vote and they will be hoping that the Bank’s latest measures will make a difference. Many believe however that now is the time for the government to act by demonstrating clear fiscal and investment policy from the centre in order to support and boost economic growth.

In the immediate aftermath of the Brexit vote, and before it, the construction sector has been vocal in calling on the government to put infrastructure investment at the top of their agenda. Both candidates in the Labour leadership election have made large scale investment in infrastructure key planks of their campaigns and so the pressure is growing for the new chancellor Phillip Hammond to act decisively. Industry needs the certainty of decisions being made and long-term plans being implemented.

Respected international organisations like the World Bank and the OECD have said repeatedly that the best way of making the wider economy more resilient would be to invest money in quality infrastructure. This would fit in with Theresa May’s stated aim of rebalancing the economy and investing in all those areas of the country that have been left behind over recent years. Words though, are cheap. It’s action that the economy and industry needs.

Much is already being made of the government’s forthcoming autumn statement and what it might contain, but such are the uncertain prospects for the economy currently that what happens over the next two months is being seen as just as important in terms of the government setting out a clear strategic plan for infrastructure investment. 

Number Ten needs to act - and quickly.

Andy Walker is the editor of Infrastructure Intelligence.