Interest rates influence many aspects of your finances, from the cost of borrowing to the growth of your savings. In November 2024, the Bank of England (BoE) reduced the interest rates to 4.75%. Prior to this, the BoE’s Monetary Policy Committee (MCP) increased the interest rates almost 14 times between December 2021 and August 2023, increasing them from 0.1% to 5.25% for a year. After August 2023, the MPC decided to maintain the base rate at 5.25% for a year. With inflation decreasing and economic growth rebounding, the MPC eventually cut rates. First, they were reduced to 5% between September and October and then further lowered in November.
These changes in interest rates affect your finances in multiple ways, from mortgages to savings. Understanding their impact is essential.
Keep reading as we explore these effects in more detail, starting with the basics.
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What is the BoE Bank Rate, and what is its significance?
The Bank Rate, set by the Bank of England (BoE), is the primary interest rate in the UK. It’s the rate at which the BoE charges high-street banks for borrowing money, and this, in turn, influences the rates banks offer on loans and savings.
This means that when the Bank Rate is raised, banks generally increase their interest rates as well. Conversely, when the Bank Rate falls, banks generally lower their rates.
In other words, increased rates can make borrowing expensive for end customers. So, if you want to buy a house or a car on a mortgage, the higher interest will mean higher monthly payments. For example, if your mortgage amount is £130,000, the loan term is 25 years, and the interest rate is 3.5%, the monthly amount will be £651. If it decreases to 2.5%, you will need to pay about £583 per month. A further reduction of 1.5% would lower the payment to around £520, saving you almost £131 a month.
What are the Effects of Interest Rate Changes?
Effect on Inflation
The rise in interest rates is an effective strategy used by central banks to control rising inflation. When interest rates are on the higher side, borrowing becomes expensive for consumers, banks, businesses, and others. As a result, everyone tends to spend less, which lowers demand for products and services. Less demand means a lower likelihood of price increases.
High interest rates can make starting or expanding a business more challenging, and existing companies may be forced to downsize or close. This can lead to job losses, and with fewer people employed or earning lower wages, there is less money to spend. Consequently, companies are under less pressure to raise wages or increase prices.
However, price increases are not solely due to internal factors. External factors like supply shortages, international energy costs, disruptions such as the Suez Canal blockage, or poor crop yields can also drive up prices.
Internally, though, central banks use interest rate hikes as a strategy to address rising inflation.
Effect on Cost of Living
When inflation rates are high, the cost of living also rises. This means that consumers cannot buy as much with their money, making everyday goods and services more expensive. In this way, the cost of living is indirectly influenced by base rates and their changes.
Currently, the UK government has set a target of a 2% inflation rate, which is considerably lower, and the economy has stabilised somewhat.
The Bank of England uses fluctuations in the base rate as a tool to manage both inflation and the cost of living.
Effect on Mortgage
When interest rates fluctuate, the mortgage rates also get affected. The impact varies depending on your home loan type.
- Variable and Tracker Mortgage: People with variable and tracker mortgages experience the effect almost immediately. As soon as the base rate is cut, the payments go down instantly and vice-versa. This happens because these mortgages move in sync with the BoE base rate.
Your mortgage contract will have all the details about how a change in the base rate will affect your mortgage rates.
- SVR Mortgage: Similarly, borrowers with a standard variable rate (SVR) mortgage also witness the impact immediately, experiencing increased rates and monthly payments when the base rate increases and vice versa.
- Fixed-rate Mortgage: Fixed-rate mortgages remain unaffected by immediate interest rate changes. However, once the fixed-rate period ends, the interest rate could be significantly higher than what you were paying before. Of the six million households in the UK on fixed-rate mortgages, about 1.4 million deals will end in 2024, and these households are likely to face higher payments. This is because interest rates were much lower two years ago. If the Bank of England doesn’t lower rates further, your payments will increase after your deal expires.
If your fixed-rate deal is ending soon, you can remortgage. It’s often advisable to stick with the same lender to save time and fees and avoid another affordability assessment. However, it’s always a good idea to shop around and research to find the best interest rates. A tracker mortgage could also be a good option in some cases.
Effect on Savings
Theoretically, when the base rates are low, the interest on savings accounts is low as well. When interest rates increase, the savings rate increases too. Since December 2021, the savings rates have continuously increased – at times even more than the current inflation rate.
Effect on Debts, Loans & Credit Cards
When the base rate is increased by the Bank of England, the interest rates on credit cards and personal loans typically rise. Now that the BoE has reduced the base rate, rates on personal loans and credit cards are expected to decrease, though it may take some time.
If your current personal loan is on a fixed rate, it won’t be affected by changes in the base rate. While credit card interest rates are usually variable, they don’t always adjust immediately in line with the base rate, so you may not see an instant change.
If you’re planning to take out a new loan or apply for a new credit card, you could benefit from a lower rate in the near future.
Effect on Pension Rates
Low base rates mean that annuity providers may hesitate to invest their money from private pensions in bonds, as these are more expensive at the moment. When base rates rise, investors are more willing to sell bonds, making them cheaper. As a result, annuity providers can offer better returns to pensioners.
This applies only to private pensions, as there is no direct link between base rates and interest rates for state pensions. If you have a defined benefit pension, you may be able to contribute more when rates are higher, as it becomes cheaper to increase contributions.
Effect on the UK Housing Rates
Prices in the housing market are largely influenced by factors, including employment rates, income levels, cost of borrowing, supply and demand conditions, and lenders’ willingness to lend. When the economy is stable or growing, there are more job opportunities, higher wages, and increased job security. With low interest rates, borrowing capacity rises. For example, in December 2021, interest rates were at their lowest, making homeownership more affordable for buyers.
The cost of borrowing is directly associated with the base rate. Lower base rates result in lower borrowing costs, while higher base rates increase borrowing costs. When the Bank of England cuts down the base rate, people can afford larger mortgages, which drives more buyers into the housing market, increasing demand for homes.
In contrast, when the base rate is higher, borrowing becomes more difficult, and fewer people can afford larger mortgage payments. This often leads to an increase in repossessions.
Homebuyers who plan to buy a home with cash or have already paid off their loans are not affected by changes in the base rate.
The base rate is decided by the Bank of England, specifically by the Monetary Policy Committee (MPC). The MPC meets approximately every six weeks to discuss and decide on the rate, with announcements typically made on Thursdays.
The MPC consists of 9 members, including the Governor, Mr. Andrew Bailey. Each member votes on changes to the base rate, considering the medium-term inflation target of 2%. The next decision on the base rate is expected on Thursday, 19th December 2024.
Do you need help in understanding the complex base rate and its effect on different economic and financial matters? Speak with us at Cangaf Accountants.
More useful links below!
Bank of England Bank Rate – Actuaries in government: This article explains how the Bank Rate influences the rates banks charge for loans and pay on savings, affecting borrowing and saving costs.
How increases in housing costs impact households: The Office for National Statistics discusses how rising mortgage interest rates can lead to higher housing costs, especially for those with variable rate mortgages or fixed-rate deals ending soon.
How are monthly mortgage repayments changing in Great Britain?: This resource provides insights into how monthly mortgage repayments vary across the country, considering current interest rates and house prices.
