Surprise as rates cut to 40-year low

Mortgage rates fell to their lowest levels for nearly 40 years yesterday after the Bank of England announced a surprise cut in interest rates to counter fears about a looming recession.

The move to reduce rates from 5.25% to 5% is the fourth cut this year, and caught industry and the City unawares.

Leading mortgage lenders reacted swiftly to the Bank's decision, slicing around £10 a month off the average £50,000 home loan. Mortgage rates are now at their lowest since 1963 - when Cliff Richard was topping the charts with Summer Holiday and the average house cost just under £3,000.

Most commentators had expected the Bank to leave rates unchanged. Despite the problems facing Britain's manufacturing industry, consumer spending remains strong, while the housing market shows little sign of running out of steam.

Three days ago Nationwide building society said house prices were rising at an "unsustainable rate", a situation partly fuelled by the low cost of borrowing. This latest cut could prompt fears of a repeat of the boom-and-bust cycle of the late 80s and early 90s.

Employers applauded the Bank's decision which they said would ease some of the pressure on manufacturing. "This will help cushion the UK impact of the global slowdown, and steady a few nerves in business," said Ian Fletcher, chief economist at the British Chambers of Commerce.

In a statement issued after its decision, the Bank's monetary policy committee (MPC) said the world economy had been weaker than expected over the past few months.

"This and the persistent strength of sterling are adding to pressures on the externally exposed sectors of the UK economy," it said. "On balance, the outlook, although highly uncertain, is for aggregate demand and output growth to be weaker than previously thought."

The Bank said it needed to keep consumer spending strong to offset the weakness in the global economy. "Monetary policy needs to balance the weaker external environment by sustaining domestic demand growth," the statement said.

Analysts did not rule out a further cut in rates. "While the UK consumer has appeared unconcerned in recent months by the world economic weakness, the rest of the economy has clearly been affected," said Ciaran Barr, chief UK economist at Deutsche Bank. "Another rate cut is certainly a possibility before year-end, especially if unemployment starts to increase."

Danny Gabay, UK economist at JP Morgan, said: "We must assume that the MPC has taken a much more pessimistic view of global developments."

The Bank will give an insight into the thinking behind yesterday's rate cut when it unveils its quarterly inflation forecast next week. Its decision came after government figures revealed last month that manufacturing is contracting at its fastest rate since the last recession.

Industry has taken the brunt of the global slowdown and, with job losses mounting, analysts are expecting worse to come. Only last week, more than 35,000 redundancies were announced in a matter of hours when corporate giants such as Reuters, ABB, Lucent and Invensys pared back staff numbers to cut costs.

Forecasters at the National Institute for Economic and Social Research warned yesterday's rate cut was a sign of the level of concern among policymakers about the health of the global economy.

"In the course of this year it has become clear that there is a substantial pause in growth in the world's major econ-omies," said Martin Weale, the institute's director. "The situation is weak in the US, Japan and Germany."

But Matt Barrett, chief executive of Barclays, said fears of recession were overdone. "There is cause for caution, not alarm," he said.

After yesterday's announce-ment, the Halifax, Britain's biggest mortgage lender, cut its new standard variable mortgage rate from 6.25% to 6%, a move that will mean a monthly saving of £31.25 for someone with a £150,000 interest-only mortgage. Its old standard rate falls from 7% to 6.75%.

Abbey National, Nationwide, Cheltenham & Gloucester and HSBC are among the other major lenders which immediately cut their mortgage rates by 0.25%.

Abbey said its "classic" mortgage rate has been reduced to 5.9% while its flexible "lifestyle" rate falls to 6%. Nationwide said its new base mortgage rate was being cut to 5.74% and its old standard rate to 6.24%.

While millions of people with standard rate and discounted rate mortgages will benefit, the hundreds of thousands with fixed-rate deals will see no reduction in what they pay.

Savers, already hit hard by a series of reductions in their returns, are the biggest losers. Most banks and building societies said savings rates were "under review" - meaning cuts are a virtual certainty.