THE BANK BASE RATE HAS DOUBLED. BUT WHAT DOES THIS MEAN FOR LEASES?
For the first time in about ten years the Bank of England raised Bank Base Rate by 25 basis points to 0.5% during their Monetary Committee meeting on 2 November.
Given that many people, often in relatively senior job roles, have never experienced a rate rise in their entire working career, the Bank’s action has, not surprisingly, generated considerable interest and some concern.
One question that is always asked when interest rates make the news headlines is whether there will be any impact on the price of leasing capital equipment. To give an answer it is necessary to go back to the environment which prevailed prior to August 2007 when Bank Base Rate was subject to fairly regular fluctuation. Those of us with long enough memories will note that leasing rates tended to change only after a sustained period of base rate increases or decreases and more often than not there was no relationship between lease rates and short term fluctuations in Bank Base Rate.
Given that the price of money (based on Bank Base Rate) is a direct cost to banks and leasing companies, why is there no clear correlation in the relative cost of funds? The answer involves a number of factors, some of which have little to do with the price of money. For example, a change in regulatory costs or bad debt provision might cause a leasing company to change their pricing structure irrespective of changes in cost of funds. That is not to say that interest rates do not play a significant part in determining the cost of leasing.
Perhaps the most important factor to consider is that Bank Base Rate sets the short term price of borrowing money but leasing companies tend to fix their cost of funds over relatively long periods. A key feature of leasing agreements is that rental payments are normally fixed for the three, four or five year periods. Rental payments cannot be increased once an agreement is in place, leasing companies would therefore be vulnerable if their borrowing costs fluctuated in line with short term changes to Bank Base Rate. For this reason it makes sense for leasing companies to ensure that their cost of funds are to a large extent fixed for the duration of leasing agreements. So the key factor influencing lease rates is not the short term cost of money (Bank Base Rate) but the cost of borrowing money over longer terms. These prices are set by ‘the market’ and reflect an anticipation of the economic conditions that might prevail in the longer term. In some cases short term and long term interest rates can actually move in opposite directions. As an example this can happen when the market expects that a short term increase in interest rates to reduce inflation will slow down the economy sufficiently to make a rate reduction in the longer term more likely as a means to stimulate economic growth. In these circumstances there would be no need for a leasing company to increase rates charged for new business because their cost of funds would not have moved in line with Bank Base Rate.
Despite the recent headlines it is worth remembering that interest rates are still at exceptionally low levels and whilst the recent decision by the Bank of England might herald a slow increase in the long term cost of funds, so far as leasing rates are concerned there should be no significant change in the short term.
The one message we might however take from the Bank of England interest rate decision is that the cost of borrowing over coming years is, at the very least, unlikely to fall, and as such now is a very good time to lock into a leasing deal that reflects the historically low interest rates that have applied over the last few years.
Source: BNP PARIBAS LEASING SOLUTIONS
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