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Who sets interest rates?
The monetary policy committee (MPC), a group of nine economists. Four are independent and the others are Bank of England officials. It is chaired by the Bank of England governor, Mervyn King.
Why such a sudden rate change?
All the most recent indicators have shown an increasingly rapid deceleration in the economy - data relating to the service sector, manufacturing, consumer behaviour, unemployment, investment intentions and the housing market are all showing signs of a severe downturn. It is also likely that next week's inflation report will show inflation falling well below its 2% target over the next two years.
Is this a panic measure?
It is certainly an unprecedented move and critics of the bank will say it proves the MPC was asleep on the job throughout the summer and into the autumn. The MPC will say the facts have changed.
Is inflation no longer a threat?
No. The global economy is slowing sharply, oil and food prices are tumbling. Although inflation is now at a 16-year peak of 5.2%, all City pundits expect it to fall sharply next year. Some think it could even go below zero - meaning prices start to fall.
So what is the committee worried about?
The MPC doesn't want to risk deflation, where prices fall, wages are forced down and spending drops, completing a downward spiral. Savings and other assets would also lose their value. Japan has lived with deflation for more than a decade after not recovering fully from the early 1990s recession.
What impact will it have on my mortgage and savings?
Homebuyers on tracker mortgages will benefit immediately, while those with variable rates will have to wait to see how much of the rate cut is passed on. The 50% of homebuyers on fixed rate home loans will see no immediate benefit. Savers' rates are likely to be cut, but banks and building societies are likely to keep them as high as they can, to keep savings flowing in.
How will the cut affect the pound?
Sterling should have collapsed following the dramatic rate cut, because it makes the currency a less attractive investment. Instead, it initially defied the odds and rose against both the dollar and the euro on hopes that the UK economy would be kickstarted by such a bold move. The half point rate cut from the European Central Bank fuelled sterling's strength, because dealers thought the ECB had not gone far enough - making the pound relatively more attractive than the euro. The pound later fell against the dollar.
Will it help to stem the rise in unemployment?
MPC member David Blanchflower has repeatedly warned that unemployment could reach 2 million by Christmas. Yesterday's cut suggests other members of the MPC now agree. The cut will take time to feed through into the labour market.
Will it help revive business and industry?
The scale of the cut surprised business leaders, who had privately thought that their calls for a one percentage point cut were likely to fall on deaf ears. But they were impressed. The CBI described the cut as "welcome", while the chief economist at the Institute of Directors, Graeme Leach, said it was "bold and aggressive ... and just what the economy needs". The Forum of Private Business, which represents 25,000 small businesses that between them employ 600,000 staff, said the cut could save small firms £750m in interest payments on loans and overdrafts, but only if passed on by the banks in full.
Will it help to revive retail spending?
Shopkeepers are facing their worst Christmas for 30 years as shoppers rein back their spending, and many retailers - who employ 10% of the UK workforce - certainly need a boost.
For some the rate cut will give immediate benefit to their bottom line: Marks & Spencer's interest bill, for instance, will be chopped by £50m next year.
Andy Bond, the chief executive of the supermarket group Asda, said the impact on shoppers and retail sales was in the hands of the banks. "A significant drop like this should help restore consumer confidence this side of Christmas, but it is essential that banks pass on this saving to their customers. Everyone has to play their part and financial institutions are not exempt."
How will it affect the housing market?
The prospect of cheaper home loans prompted an immediate reaction: a jump in the number of people logging on to property websites. Between 1pm and 2pm yesterday, traffic on the Rightmove website was up 20% on Wednesday's levels.
But Richard Cotton of estate agents Cluttons said the cost of borrowing was now only one factor holding back the housing market: "We now have the added issue of redundancies and a rise in unemployment, which is a further drag on the immediate outlook".
The cut will be little benefit to first time buyers, as they still have to find a 25% deposit to get a mortgage and few will be tempted into the market when the likelihood is that house prices will be down another 10% in a few months.
- Bank of England
- Interest rates
- Banking sector
- Economics
- Credit crunch
- House prices
- Savings
- Mortgages
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