Gift or a Poisoned Chalice-The Effects of VAT and Interest Rate Reduction

The effects of VAT and interest rate reduction

What are the real affects of the government’s gifts of lower interest rates and reduced VAT levels? Are they really a boost to the economy or a poison chalice causing confusion and extra administration for individuals and businesses alike?

The answer depends quite simply on where you stand in the cycle of the economy. For most of us, the affects of the VAT reduction are just not material – 1p on a Mars bar. It’s just too small to make a huge difference. It is more of an administrative task for the stripe suited grey accountants than a saving (or encouragement) to the average man on the street. It is true to say that those boutique shops embracing the VAT reduction are using it as a way of advertising, but I’m not sure that it has helped to get consumers through the door. Certainly, if it is making a difference, it is not enough of a difference to change our fortunes.

The interest reduction, on the other hand, equates to a 30% drop and this is big enough to have the potential to make a much bigger difference; the critical factor, of course, being that the banks must pass on those rate reductions.

For businesses and individuals who have interest only in borrowings, the recent one-point reduction has a huge impact on monthly repayments. Lower interest will improve the margin for error, and this has to be positive. This will certainly assist in the survival of those borrowing, but will it help the housing market?

The housing market is fundamental to the UK economy. With falling house prices, liquidity that existed 6 months ago has all but gone. Bank security is everything. Security is the gap between the loan value and the market value of the house. Lenders only ever lend when there is adequate security in place. This ensures full recovery of their debt if the borrower defaults. As house values fall, the amount of security available also reduces and the loan to value calculation means there is no money to lend. Indeed, for those who have taken mortgages in recent times at 95% loan to value will now find themselves in a negative equity situation. Some borrowers, who fixed their mortgage interest rate won’t even be able to take advantage of the lower interest rates.

For those with money – and the stomach to invest – it is a great time to buy or invest in cheap assets, but be warned that this is not a game for amateurs and it is very easy to get burnt. Those who succeed will be those with experienced professionals around them, such as turnaround practitioners who have learned these unique skill sets during the last recession and finessed in the buoyant times that followed.

For those with money – and the stomach to invest – it is a great time to buy or invest in cheap assets, but be warned that this is not a game for amateurs and it is very easy to get burnt. Those who succeed will be those with experienced professionals around them, such as turnaround practitioners who have learned these unique skill sets during the last recession and finessed in the buoyant times that followed.

For the others who have bank deposits but no confidence or skills required to profit from the downturn the reduced interest rates, their rate of saving has been reduced with immediate effect and that does nothing to boost confidence.

So, where do you stand in the economy? Are you looking to make gains from the downturn whilst there is blood on the streets or are you facing negative equity and reducing saving rates? The government has meant theses reductions as gifts but to some they are a poison chalice.