Interest Rates for Dummies

Interest rates can be confusing. There is a huge range of interest rates – anything from 0% a year to 2,000% on some extortionate pay day loans.

Interest rates basically reflect the cost of borrowing money. The most important interest rate is the base rate (or repo Rate) set by the Bank of England.

The Bank of England change interest rates to try and influence the inflation rate in the economy. The bank of England need to try and meet the government’s target of 2% inflation. However, they will also be sensitive to other objectives such as economic growth and unemployment.

How Interest rates affect individuals and the economy

  1. Higher interest rates increase the cost of borrowing
  2. Higher interest rates increase mortgage interest payments causing consumers to have less disposable income
  3. Higher interest rates cause an appreciation in the exchange rate. An appreciating exchange rate causes lower aggregate demand and lower inflation

Bank Rates and Bank of England Rates

Despite the Bank of England keeping interest rates the same. The nationwide building society recently announced that its own mortgage rates would be increasing. This shows that commercial bank rates are often independent of the Central Bank rates.

The nationwide justify their rate increases on fixed rate mortgages due to the increased cost of interbank lending. They point to the rise in the Libor 3 month interbank rate and say it is now more expensive for them to borrow money.

More on: Understanding interest rates
Predictions for mortgage interest rates in the UK
Interest rates at Bank of England