Whether you’re a borrower or a saver, running a business or a household – interest rates will have an impact on you and your money.
The Bank of England’s base rate helps support the economy by regulating inflation – encouraging people and businesses to either save, or borrow and spend.
What makes the base rate rise or fall?
The base rate is the UK’s official borrowing rate for banks and building societies, and influences the interest rates they offer to customers.
The base rate is reviewed against the UK inflation target of 2%, by the Monetary Policy Committee (MPC).
Inflation is the rate at which the prices of goods and services increase.
For example, if inflation is 2%, it means prices are 2% higher, on average, than they were a year ago – a £1 loaf of bread 12 months ago would now cost £1.02.
Inflation can rise and fall because of supply and demand. For example, the coronavirus lockdown reduced the need for fuel. The price of oil dropped – and petrol became cheaper – contributing to a fall in the UK inflation rate in May 2020.
A target of 2% keeps inflation low and stable – it allows prices to increase at roughly the same rate as wages – to encourage some economic growth and keep the cost of living affordable.
When the base rate rises
If the MPC feels inflation is rising too quickly it may try to limit it by raising the base rate.
When the base rate goes up, interest rates may go up.
It then costs more to borrow money, but it also means you can earn more on your savings – so people may be encouraged to borrow less and save more. This reduces demand for certain goods and services, which could slow inflation down.
When the base rate falls
If the MPC feels the rate of inflation is too low, it will try to increase it by cutting the base rate.
When the base rate goes down, interest rates may go down.
It costs less to borrow money, but means you earn less on your savings – so people may be encouraged to borrow and spend money rather than save it. This increases demand for certain goods and services, which could lift inflation.
How often does the base rate change?
The base rate is reviewed roughly 8 times a year. It doesn’t change every time and it can stay the same for years.
In 2008, the global financial crisis saw the UK base rate – and interest rates – fall and they remain low in 2020.
In 2020, the base rate of interest reached a record low, in response to the coronavirus pandemic.
What are negative interest rates?
If interest rates in the UK were to fall below 0%, they would become negative. Some countries, such as Switzerland, Denmark and Japan have had negative interest rates in 2020.
Central banks, such as the Bank of England, may use negative interest rates to try and boost the economy further by encouraging people to borrow and spend money – and save less. For example, if you have savings in a variable account, negative interest rates could mean that you’d earn no interest on your savings.
Some banks allow you to fix the interest rate you earn on your savings over a set term. If you have a fixed rate savings account, for example, you’re less likely to be affected by changing interest rates. However, you may be unable to access your savings during the fixed-rate term.
Explore: Types of savings accounts
Why do interest rates matter?
Interest rates can affect:
- the way people spend money
- how much it costs to borrow money
- how much people save
It could be cheaper to borrow when interest rates are low
When it’s cheaper to borrow money it can be a good time to get a mortgage or a car loan, for example, depending on your own circumstances. Businesses may also look to borrow funds so they can expand, or employ more staff.
Bear in mind – if you borrow money when interest rates are low, you need to make sure that you can afford the repayments now and in the future – in case interest rates go up.
When interest rates are high, people and businesses may not be able to afford to borrow and spend in the same way as if interest rates were low.
Earn more on your savings when interest rates are high
A higher base rate is good news for savers – as you may be able to earn more interest on your savings. This can encourage people to save more than when interest rates are low.
How much changing interest rates will affect your savings depends on the type of savings account you have and how much you have saved.
How can changing interest rates affect your mortgage?
As interest rates rise and fall, so can mortgage rates. How this affects you depends on the:
- type of mortgage you have
- amount you’ve borrowed
- length of your mortgage term
If you have a fixed-rate mortgage – the interest is fixed for a set period of time. If interest rates change, generally during this period, it won’t affect your fixed rate or your monthly payments.
If you’re on a variable rate mortgage, or have a tracker mortgage, a change in the base rate – and interest rates – is likely to have an impact on your monthly payments.
Keep in mind – mortgage rates are based on a number of different factors, not just interest rates.
You can use our mortgage calculator to work out how your monthly payments might be affected.