Last updated 05:16, Friday, 21 November 2008

Spend, spend, spend has been the message coming out of the Treasury and the Bank of England over the last few weeks.

The cut in bank rates may help borrowers and home buyers, but savers will suffer as returns fall

With the economy heading for recession, the unexpected 1.50 per cent reduction in the Bank of England base rate and rumours of possible tax cuts represent a concerted bid to encourage the UK to spend its way out of a recession.

By reducing the base rate to its lowest level since 1954, the Bank of England is making it cheaper to borrow and less rewarding to save. They want to put money back into people’s pockets, which they hope is spent rather than saved.

By taking the money out of our pockets and passing it on to businesses, the theory is that the economy is given a boost, jobs are saved, and the recession is relatively short-lived

The reason the Bank of England has previously been reluctant to reduce interest rates so dramatically is the risk of triggering inflation.

With commodity prices already in decline, inflation is likely to fall to around one per cent by the end of 2009 and that risk is now considered to be negligible. Once the reduction in mortgage payments is taken into account, inflation may even fall below zero.

However, as with all economic policies, there are winners and losers. While those on variable rate mortgages will benefit from a significant reduction in their monthly payments, the news is less welcome for savers.

If savings rates fall in line with the reduction in the Bank of England base rate, someone who is retired and dependent on interest from their savings will see their monthly income fall by around a third.

With unemployment rising to 1.82 million, those who have recently lost their jobs, or are worried about future job cuts, are another group unlikely to feel the urge to spend.

If you haven’t already planned your holiday for 2009, now might be a good time to re-think. One of the knock-on effects of low interest rates is that the returns on money invested in the UK are lower. As a result, the value of the pound will fall and you may find it more expensive to go abroad.

If you were lucky enough to travel to America earlier this year, you would have enjoyed an exchange rate of almost $2 to the pound; that has already fallen below $1.50.

So, not so good for those planning a holiday abroad, but good news for those whose business is linked to UK tourism, as more of us will stay at home and the UK becomes a cheaper place to visit.

With the Bank of England refusing to rule out further reductions in the base rate, we are entering an unprecedented era.

While it is almost certainly too late to avoid a sustained recession, the concerted action may help to stimulate a quicker recovery.

However, it is worth remembering that the effects of low interest rates go far beyond the immediate focus on mortgage payments and the possibility of stimulating some form of recovery in the housing market.

Chris McDonald is head of marketing at the Cumberland Building Society. Visit the website at www.cumberland.co.uk