The Bank of England (BOE) today offered the UK an early Christmas present by dramatically slashing interest rates by a whopping 1.5%, making it 3.0% - the lowest level since 1954. The European central bank followed suit 30 minutes later with a half percent cut.

One of the main banks, Lloyds TSB, announced that they will pass on the full cut to borrowers and this will put pressure on the rest of the banks to do the same.

Many commentators are rolling their eyes and proclaiming that these "desperate measures" will not save the British economy form entering a deep, long recession. It must be so much fun going through life as a glass-half-empty kind of person. It makes you wonder what actually gets these guys excited.

So let's put things into perspective shall we?

The last time the UK's interest rates where reduced so dramatically was in the early years of Margaret Thatcher's government. In 1981 the rates where slashed by 200 basis points from 14% to 12%, but today's cut is larger in proportion. Cutting the base rate from 4.5% to 3% the BOE effectively slashed a third of the cost of borrowing. That's significant because this move confirms that, while the Banks' normal concern is controlling inflation, it has now shifted its attention to correcting the UK's economic downturn.

Today's cut will work in conjunction with the other measures introduced by the government to restore confidence, not only among consumers but also among banks. Until now banks have regarded each other with distrust which has kept LIBOR stubbornly high.

What is the LIBOR and why is it important?

The LIBOR rate officially stands for the London Interbank Offered Rate. This is the rate at which banks borrow money from each other in the wholesale money markets. When the LIBOR rate is consistently high, mortgage lenders will quickly increase the cost of their mortgages to reflect this. When the LIBOR is high, lenders face a shortage of money to fund competitive deals for normal borrowers like you and me and as a consequence up their rates to make a larger margin on the little money they have available to lend.

With LIBOR now being substantially higher than base rate many economists feel that it will soon come down and banks will once again have money available to lend to the general consumer. In theory this should restore confidence and boost the economy.

So how long will it take for it to work?

It's always said that there's a delay in interest rate cuts filtering through to the real economy. Considering the substantial size of this reduction we could however see it filtering through much quicker. The Bank of England has now put the UK economy firmly ahead of the curve and if the majority of the cut filters through to the LIBOR and the rate structure as a whole, we could soon see the banks loosening their purse strings. Either way the banks are running out of excuses not to lend.

Should you need a little guidance or advice, I'd be more than happy to spend some time with you either on the phone or face to face over a coffee. So give me a call in the office on 0207 2234 109 or visit the Contact Us page to drop me a line.

I look forward to hearing from you soon.

Mike Smuts
Property investor and Managing Director of Smuts & Taylor.