Waning confidence will result in little material effectPosted by oblixcapital on Nov 02 2016
The Bank of England (BoE) has finally broken its seven-year record and cut its base rate from 0.5% to 0.25%, which is a new historic low. While this rate cut was anticipated, the knock-on effects for businesses, borrowers and savers are likely to be somewhat subdued.
A common assumption businesses make is that any reduction in the BoE base rate will transmit to the end borrower, and this was partly the aim of the Bank, as lower costs to businesses typically translate into further hiring and investment for firms across the spectrum. However, the reality is that only some businesses will feel these effects for two reasons. First, borrowing rates were already cheap and have been for a long time, so the desired effect of a further 0.25% cut is questionable as we’ve been witnessing ‘bubbles’ building across all asset classes. Second, since the 2008 financial crisis, banks have been slow in passing lower costs on to borrowers, as they continue to attempt to tidy and rebalance their balance sheets. It’s also worth noting that a lot of banks have their own internal base rate, which is typically higher than the BoE rate, so any reduction in the latter does not automatically translate into lower borrowing costs for the borrower.
It’s important to note that in the wake of Brexit many businesses, regardless of their size, are beginning to lose confidence. They are, therefore, not willing to take on more debt until there has been further clarity on the outcome of the exit negotiations with the EU. While the reduction in rates may have caused a small element of calmness following the decision to leave the single market, it’s very unlikely that the monetary policy will offset the political uncertainty businesses are currently experiencing.
Unfortunately for business savers, banks have been faster to react to the BoE decision by reducing the interest they pay on saving and deposit accounts. Some banks have even taken it one step further by announcing to their customers that they could potentially be charged for keeping funds on deposit if the BoE reduces base rates further.
However, there is some hope for borrowers. For those businesses or retail borrowers who have tracker mortgages linked to the BoE rate, then the recent reduction in rates can only be seen as positive. Another encouraging outcome is that the pound has continued to fall against both the euro and the US dollar. So for any business that produces and manufactures in the UK, and exports to Europe or US dollar-denominated economies, the recent decision will be a welcome bonus.
Any extra savings a retail borrower makes should encourage further spending on goods and services, which in turn encourages hiring and investment by businesses – the real aim of the BoE. The banks being the main facilitator in this are faced with the dilemma of trying to make a profit for its shareholders or risk clashing with this ultimate motivation for the BoE.
Written by Rishi Passi, CEO at Oblix Capital, and published by the NACFB, in their October edition of the magazine.