Could an interest rate reduction reduce government expenditure?
A 1% reduction in the Bank Rate would reduce the UK government's annual interest charges on the national debt, but the exact amount of the reduction depends on the proportion of the debt that is sensitive to changes in short-term interest rates.
According to the Office for Budget Responsibility, a 1% decrease in short-term interest rates would lead to a reduction in debt interest payments of approximately £6.5 billion in the first year. This impact would diminish slightly over time as the immediate effect on short-term debt lessens, and only newly issued debt benefits from the lower rates.
Compare this saving with the expected £2bn saving by restricting the winter fuel payment to pensioners receiving Pension Credits.
Reducing the Bank Rate by 1% in the UK would have a number of potential consequences aside from the reduction in debt interest charges:
- Lower Borrowing Costs: For businesses and consumers, loans and mortgages would become cheaper, potentially boosting spending and investment.
- Weaker Pound: A lower interest rate typically makes a currency less attractive to investors, which could weaken the pound, potentially increasing inflation due to higher import costs.
- Increased Inflationary Pressure: Cheaper borrowing could stimulate demand, potentially leading to higher inflation, particularly if the economy is near full capacity.
- Boost to Economic Growth: Lower rates could stimulate economic activity by encouraging borrowing and spending, helping to counteract economic slowdowns.
However, the effectiveness of such a rate cut would depend on the broader economic context, including inflation levels and global economic conditions. But it does beg the question, why is the Bank of England holding back further interest rate cuts when the advantages would seem to outpace the disadvantages?
