When it changes, the Bank of England base rate is something that’s featured heavily in the news. But why is it important and when does it matter to you?
The base rate is the interest rate that the Bank of England sets, in turn, it affects the interest rates that banks, building societies and other financial services offer. The base rate changes depending on economic conditions and influences the way consumers behave:
- Low interest rates mean that borrowing is more affordable, encouraging consumers to spend more. When interest rates are low we’re more likely to consider buying a car using finance or take out a larger mortgage
- In contrast, high interest rates mean you’ll earn more on savings and pay more when borrowing. As a result, it encourages people to save rather than spend
The Bank of England’s monetary policy committee sets the base rate, with members voting to leave base rates as they are or change them.
How has the base rate changed over time?
In recent times, we’ve become used to low-interest rates but this hasn’t always been the case.
The current Bank of England base rate is 0.75%. It’s been low for over a decade, following the 2008 financial crisis. In April 2008 the base rate was 5%. However, this was slashed several times over the course of a year in an effort to improve the economy and encourage consumers to spend and support businesses. In August 2016, it was cut even further, to 0.25%, taking it to a historic low. Over the last two years, it has increased but at a very slow pace.
Whilst we’ve experienced low interest rates for over a decade, this isn’t the historic norm.
During the late 80s, the base rate was far higher. In fact, the interest rate reached 15% in 1989. There are many factors that led to this decision but one of the key reasons was that it was seen as a way to reduce inflation.
The current interest rate and that of the late 80s are extremes. Looking at the historical average, interest rates have usually fallen between 4% and 6%.
But how will the Bank of England base rate change in the future? It’s impossible to say with certainty, but economic turbulence caused by ongoing Brexit uncertainty could mean that interest rates will fall even further; good news for borrowers but bad news for savers.
At the last monetary policy committee meeting in November, the base rate was held. However, it was the first time since June 2018 that this wasn’t a unanimous decision. It could signal that the base rate will be cut further if the UK leaves the EU in bid to support the economy.
The impact on your finances
The base rate set by the Bank of England affects the interest rate commercial banks will lend money. It’s used as a benchmark when lending to businesses and individuals.
You’ve no doubt noticed that savings have been benefitting from poorer interest rates over the last decade. If, since the financial crisis, you’ve been a saver rather than a borrower, you’re probably worse off.
For much of the last decade cash savings are likely to have grown by only small amounts. In fact, once you factor in inflation, your savings have probably declined in real terms. This means the spending power of your savings has been reduced.
In the past, cash savings may have offered you a way to grow your wealth safely over the long term. But lower interest rates may now mean it’s more appropriate to invest in order to outpace inflation.
In contrast, borrowers have benefitted from the low interest environment. It’s cheaper than ever before to borrow money. The interest rates for credit cards, loans and other forms of borrowing are competitive.
One of the areas you may have noticed this in is your mortgage. Our mortgage is often the largest loan we’ll ever take out and interest payments can be significant. If you had a tracker mortgage, which tracks the Bank of England base rate, at the time of the financial crisis, you’ll have noticed minimum payments fell.
Lower interest rates make borrowing more affordable. They also present the opportunity to overpay and reduce debt quicker, whilst paying less interest.
The Bank of England base rate may affect the best way to use your money. At some points, it’s wise to quickly pay off debt but in others, it can be more prudent to save or invest your capital. If you’d like to discuss how to get the most out of your wealth in the current low interest environment, please contact us.