More rises! A summary of interest rate movements
More rises! A summary of interest rate movements
The Effects of a Rise in the Bank of England Base Rate by Charlotte Woodward LLB Hons
The Bank of England (“BoE”) base rate has risen to 4.50% as of Thursday 11 May 2023. This is an increase of 0.25% from the previous rate of 4.25%. The BoE base rate is determined by the Monetary Policy Committee (“MPC”), who meet every six weeks to assess the economy in the UK and set the appropriate rate. To determine the rate, they evaluate the current state of the economy and what they foresee the economy to look like in the near future. This is the 12th consecutive time that the base rate has been increased by the MPC.
Why does the base rate increase or decrease?
‘Base rate’ is the interest rate set by the MPC, which influences people’s overall borrowing and spending, and as a result of this, how much things cost. The constant increase in the BoE base rate over the past few years has been a response to escalating cost of living. The current inflation rate is 10.1%, despite the target rate of inflation being five times lower than this at 2%. High inflation influences the affordability of goods and services for UK households. In an effort to control the rising rate of inflation, base rate is increased.
Base rate sets the interest rate that central banks will charge commercial banks and building societies for loans. The rise in base rate has thus resulted in the cost of borrowing money to increase. Effectively, by increasing the costs of borrowing money, this slows down spending in the UK and encourages people to save. The demand for goods and services is lessened because of this decline in spending. This in turn helps to lower prices and subsequently slow down the rate of inflation.
Problems caused by an increase in the Bank of England base rate
In an attempt to maintain a steady inflation rate by increasing the Bank of England base rate, people are hit with higher loan costs – meaning an increase in mortgage rates and credit card interest rates.
There are different types of mortgage rates on offer to those who are buying/own a house. These are fixed and variable mortgage rates. Those with a fixed mortgage rate are not affected by a change in base rate. Tracker rates are variable and follow the BoE base rate. Those with a tracker mortgage type will therefore be negatively affected by an increase in base rate as they will pay a higher rate of interest on top of the cost of the mortgage itself. This means that those individuals are paying more each month without clearing a higher amount of their mortgage. Similarly, those with a Standard Variable Rate (“SVR”) mortgage may also be affected by a rise in base rate. Lenders’ SVR tends to follow base rate with lenders raising their rates in line with a base rate increase, however it must be noted that lenders can also make changes to their SVR whenever they wish and is not completely determined by the current base rate.
The base rate also influences the cost to borrow money through credit cards, bank loans and car loans. A higher rate means lenders increase their lending price and the interest rates applied.
Benefits of an increased base rate
Despite the negative impact a rise in base rate has on individuals with variable mortgages and loans, an increase in the BoE base rate can have a beneficial impact on individuals who are looking to save.
The interest rates currently on offer with commercial banks and building societies are increasing in conjunction with the rise in the BoE base rate. Having larger interest rates on offer, in theory, allows those saving money to benefit from greater returns on their cash/savings account deposits. This gives more opportunity for those looking to keep their money in cash deposits and save their pennies, rather than those looking to buy property or take loans out for other ventures. Although the base rate increase has influenced the interest rates on offer to also rise, it can be said that the banks have been slow to follow suit. The banks increase in interest rates, especially on offer for easy access accounts, do not fully represent the increases that have taken place. Furthermore, with inflation at 10.1% it can still be said that even with an increase of interest rates on offer to meet the current base rate of 4.5%, cash deposits would not match the change in the value of money in real terms and would be losing value over time.
In summary, it is necessary for the BoE base rate to increase and decrease to create some balance in the economy. Where inflation is high, it is arguably a necessary step to curb living costs by discouraging spending and encourage saving. Furthermore, there are a number of ways people benefit and at the same time suffer with these changes
Sources used: