The Bank of England's base rate would peak close to 3% to protect mortgage payers from a big increase in monthly interest payments, a senior Bank of England official said.
David Miles, a member of the central bank's interest rate setting committee, said base rates would remain lower than the long run average to keep mortgage rates affordable. Banks would need to maintain a healthy margin between the cost of money charged by the Bank and the rates they charge customers unlike their policy in the boom years when lending margins could be wafer thin, he said.
In a speech at Leeds University Business School, Miles outlined how base rates had averaged about 5% since the Bank was founded in 1694. In the 1990s, mortgage rates were commonly 2.5-3 percentage points above the Bank's base rate but, in 2006 and 2007, that gap had fallen to only 0.5 percentage points or less. "The new normal for monetary policy will probably involve setting Bank rate on average at a lower level than before the crisis," he said.
Base rates are important because they set the benchmark for borrowing by high street lenders from the central bank. In the late 1990s, they peaked at 7.5% before falling to 3.5% in 2003 and were 4.5% to 4.75% throughout most of 2005 and 2006.
Even in the depths of the recession there was an expectation among most businesses and homeowners that rates would go back to the long run average following the economy's full recovery.
The message from most, if not all, policymakers is that to maintain margins on commercial and home loans of about 2 percentage points, base rates need to remain at or below 3%.
Mark Carney, the Bank governor, said this month in the quarterly inflation report that rates were likely to start rising next year and peak about 3%. He said it was the central bank's view that the UK economy would continue to underperform for several more year.
Miles said the fear of another crash would encourage investors to favour UK government bonds over other assets, driving down the market interest rate.
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