How the UK rate cut will affect the british people

The Bank of England was called upon by economists to take action in an attempt to avoid the country going into recession by significantly cutting interest rates, but it came as a surprise to many after the Monetary Policy Committee (MPC) reduced the bank rate by one and a half percentage point, taking Bank rate from 4.5% to 3%.

This puts today's rate at its lowest since 1955 and is the biggest single monthly cut since 1981.

Many economists had predicted a half point reduction, but had hoped for a more substantial full percentage point.

So what has caused this unexpected strategy change by the MPC?

Earlier this year we were told to expect a rise in interest rates to tackle high inflation, but the last month has brought rates down from 5% to 3%.

After the economy took a severe blow, fears were growing that the UK was headed for a painful economic slowdown, lasting for several years.

Recent figures supplied by Halifax indicate that house prices are falling at their fastest rate for 25 years. October brought a 2.2% reduction in prices and 13.7% over the last year. The average UK home is now priced at just £168,176, close to £30,000 less than this time last year, pushing prices back to levels seen in October 2005.

Other data released this week has revealed that the service sector has shrunk for the sixth month running in October, while manufacturing output reduced for the seventh consecutive month in September.

Business bodies and trade unions have welcomed the cut, however, there are fears that consumers will lose out.

The cut in rates will come as good news for borrowers, as rates will be passed onto lenders so consumers will have lower mortgage repayments. Those likely to benefit the most from the rate cut are consumers with tracker mortgages which directly reflect the Bank rate. This means that they will benefit from the full 1.5% cut. This will reduce repayments on £150,000 mortgages by £125 per month.

Lloyds TSB has assured it will pass on the full rate cut to its variable rate mortgage customers. However, many consumers with standard variable rate (SVR) may not be so lucky.

There are concerns that many institutions will not pass on the rate cuts by the full 1.5 points. After last months cut, Thirty two lenders have yet to respond and out of the 57 that did, only 24 reduced their rates by the full half a point cut.

HSBC has been criticized as it failed to change its rates following the October rate reduction and there is a possibility it may not even reduce rates following yesterdays cut.

Other major lenders that didn't pass the half point cut onto their SVRs include Abbey and Northern Rock, both making 0.15% reductions. Nationwide Building Society also passed a 0.30% cut and Alliance & Leicester (A&L) reduced its SVR by 0.25 points.

Consumers borrowing new mortgages are set to lose out even after yesterdays significant cut.

A number of lenders recently re-priced their tracker mortgages by increasing rates. Abbey increased rates on its tracker deals by half a percentage point earlier in the week, while Northern Rock, A&L and Cheltenham & Gloucester have all taken their trackers off the market. Analysts have warned that rates applied to the new product ranges they plan to launch in coming months may be set higher than the products recently lifted.

Lenders have argued that they have no choice because wholesale funding costs have not reduced in line with Bank rate cuts, but this has sparked wide criticisism. One of the leading factors to the sheer speed of falling house prices has been blamed on the lack of availability of mortgages. The Government has urged banks and building societies to help alleviate the mortgage crisis by lowering their rates and making mortgages more available.

There are big concerns for savers, as yesterdays rate cut will be passed in full to many accounts. This means that majority are likely to be paying less than inflation, currently at 5.2%, which effectively means savers money is being eroded.

It is therefore important for savers to seek out the highest possible returns for their savings. However, only the first £50,000 of your money is protected by the Financial Services Compensation Scheme (FSCS) under any one institution, so it would be unwise to invest more than this amount in one place. If you are lucky enough to have more than £50,000, ensure you spread it across several institutions. For full details of which banks fall under the same institution, and which banks are classed as individuals, see my hub - List of Banks by Institution.

Savings rates have been extremely high over the past few months, with some borrowers paying significantly more than Bank rate, offering rates exceeding 6%. While the rate cut has caused many institutions to lower rates, some are still yet to pass on the cut, so now is the time to take advantage of a fixed rate account allowing you to effectively freeze the interest rate you are paid for 12 months. Capital one is currently offering 5.70% over 12 months on its fixed term bonds. If you can afford to lock your money away for this period then this is your opportunity to beat the cut and continue earning rates well above the Bank rate. This will also allow you to stay ahead of inflation so your money does not lose value.