Post-crash interest rate cuts have reduced annual mortgage costs by over £22bn

Outlook for interest rates mean that a different response will be needed in the next downturn

Cutting interest rates will have far less impact in the next downturn than the £22-4bn annual boost to households with mortgages they provided following the last one, according to a new report published today (Thursday) by the Resolution Foundation.

It says that now is the time to look at what other policy changes will need to play a greater role in staving off the effects of recession next time around,

Renewed Interest – the Foundation’s report on the role of monetary policy in crisis and beyond – considers the impact of interest rate cuts in the last downturn and the potential impact of cuts in the next one, along with other possible monetary and fiscal policy responses.

The report estimates that the 4.5 percentage point cut in interest rates between October 2008 and March 2009 reduced annual mortgage costs by between £22bn and £24bn between 2009 and 2015.

It adds that interest rate cuts will have had an impact far beyond mortgage costs. Returns on simple savings for example saw a £10.8bn loss from reduced savings rates, while many other indirect effects are impossible to quantify.

The Foundation warns that the scope of rate cuts is likely to be greatly reduced by the time of the next recession. Using data on the average chance of annual recessions since 1974 it estimates that there is a 60 per cent chance of the UK experiencing a downturn in the next five years.

The report then uses market expectations for interest rate rises to show that should the UK experience a recession in 2021, when the base rate is forecast to be 1.6 per cent, cutting interest rates again to 0.5 per cent would reduce annual mortgage costs by £8.5bn – roughly a third of the over £22bn boost experienced following the last downturn.

It notes that should the next downturn occur before 2021 then the scope for using interest rate cuts to stave off the worst effects of recession could be even more limited.

Renewed Interest goes on to consider other possible policy responses in the next downturn, including further quantitative easing, negative interest rates, higher inflation targets and a different balance between fiscal and monetary policy measures.

It says that pursuing any of these policies presents challenges, including questions about the efficacy of further QE and feasibility of long-term negative interest rates in the UK. The implications of an expanded role for fiscal policy, and creating sufficient fiscal headroom before the next recession, also means that the debate around responding to the crisis should be as big an issue in Westminster as in Threadneedle street.

The Foundation says that, although there are no easy answers, with interest rates set to stay low for a sustained period policy makers need to consider a wider range of policy measures now rather than waiting for the point at which they are needed.

Matt Whittaker, Chief Economist at the Resolution Foundation, said:

“With the UK economy relatively buoyant compared to many of its competitors it may seem premature to start talking about what to do in the next crisis. But the reality of the economic cycle means that we are likely to be closer to the next downturn than the last one, and a proper assessment of counter-recessionary measures should be made before they’re used, rather than while they’re being implemented.

“The dramatic slashing of interest rates in the wake of the last crash has had a huge impact in staving the worst effects of the downturn, providing a boost of over £22bn to mortgagor households annually.

“But we’re unlikely to be able to rely on such policy action again as many of the tools available to the Bank have been blunted. In the absence of significant rate cuts, we need to consider the efficacy and wider implications of other possible responses.

“This brings into question the role of alternative policy options to increase the scope for interest rate changes, using other monetary policy approaches or accepting a bigger role for fiscal policy in countering the downturn.”

Notes to Editors

• The Foundation’s estimate for the impact of rate cuts on reduced mortgage holds constant the £1.4 trillion mortgage total of 2008 in order to better isolate the direct effect of base rate cuts on mortgage repayments.
• Embargoed copies of Renewed Interest are available from the press office.