A quick guide to interest rates

According to the Bank of England, the resurgence of coronavirus across Europe and a lack of clarity over the UK's future trade relationship with the EU are likely to slow the UK's economic recovery. Faced with this painful double whammy of factors, the Bank's Monetary Policy Committee recently voted unanimously to keep interest rates at their historic low level of 0.1%. Some financial experts believe this could mean that interest rates will move into negative territory next year.

What Are Interest Rates?

Every loan comes with interest, that is a set amount of money added on as a surcharge for borrowing. If you're a saver, it's the same except the bank or building society will pay you interest because they are hiring your money.

The interest rate determines the amount you receive from a lender or pay to a borrower, which depends on the Bank of England's bank rate (or base rate), set at meetings throughout the year.

The bank rate is the interest rate that banks and lenders pay when they borrow from the Bank of England, and it influences the rates lenders charge to borrowers and pay to savers.

Why Do Interest Rates Matter?

If interest rates go up, the cost of borrowing could become more expensive. Homeowners on variable rate mortgages may see an increase in their monthly payments, which means less money is left over to spend on essentials. Of course, interest rates can also go down, lowering the cost of borrowing. While borrowers welcome interest rate cuts, they are an inconvenience for savers who will earn less money from their deposits.

Usually, if the economy is looking a little sluggish, the Bank of England will lower interest rates to increase spending. If the central bank predicts inflation will rise above its inflation target, it will raise interest rates to reduce spending.

The Immediate Future

The Bank has said it has no intention of raising interest rates until significant progress has been made toward reaching its 2% inflation target. It also hasn't ruled out using negative interest rates to boost the economy, one of the many tools in its toolbox. If this happens, we enter a topsy-turvy world where banks could charge savers for holding their money. This encourages them to lend money and businesses to borrow, giving the economy the jolt it needs. It could also mean that banks are obliged to pay people interest on their home loans.

November 2020