Bank Rate – What Is It, And How Does It Affect You? – Forbes Advisor UK

The Bank of England has kept the Bank Rate at 5.25% (14 December 2023).

The Bank describes the Bank Rate ‘the UK’s single most important interest rate’. Then generally referred to as the Base rate, it last stood at today’s level in 2008.

Here’s what you need to know about the Bank Rate, why it’s so important, and what effect it has on our finances.

What is the Bank Rate?

The Bank Rate determines the interest rate we pay when we borrow money or have credit card debt, and how much we earn on an interest-bearing account.

It is used by the Bank of England to help control inflation – the increase in prices over time. The Bank has a mandate, set by the government, to keep UK inflation at 2%, a figure generally seen as healthy for the economy as a whole.

Over the past year, it has missed its inflation target by several percentage points. UK consumer prices rose by 4.6% in the year to October 2023.

High inflation is not specific to the UK, and other nations’ central banks are also engaged in battling inflation, which has spiked due to soaring energy prices triggered by the war in Ukraine and a post-pandemic global supply chain bottleneck.

The UK Bank Rate is set 10 times a year by the Bank of England Monetary Policy Committee (MPC). The MPC’s next rate-setting announcement is on 1 February 2024.

Why is the Bank Rate important?

The Bank Rate is important because it influences the rates banks and building societies charge people to borrow or pay them on their savings.

If it changes, these financial institutions normally follow suit and alter their interest rates on both loans and savings products, so you’ll feel the impact differently depending on whether you are borrowing or saving.

If rates fall and you have a loan or a mortgage, your interest payments may get cheaper. And if you have savings, you may be paid less interest. If it rises, as it has done for the past year, you’ll pay more interest on debt and earn more on deposits.

How does a rate rise fight inflation?

When interest rates rise, borrowing becomes more expensive. 

In theory this puts people off from spending and encourages them to save instead. As demand for goods and services drops, prices should fall, helping to reduce inflation levels.

The danger is that an excessive squeeze on spending can lead to an economic downturn because companies struggle to generate revenue.

That is why the Bank of England increased its Bank Rate incrementally – 14 times since December 2021, when it stood at just 0.1%.

How do interest rate rises affect mortgages?

When the Bank Rate changes, your lender should write to tell you how you will be affected and when any changes will take effect.

If you’re one of the UK’s two million mortgage borrowers with a tracker or variable rate deal, your payments will rise almost immediately following the Bank of England’s latest base rate decision.

If you have a fixed-rate mortgage, you won’t be affected by the latest rate hike until your existing deal runs out. Once you start looking for a new deal, however, you may find the rates on offer are much higher than when you last fixed.

If your fixed-rate mortgage is due to expire in the next three to six months, it could be worth looking now with a view to potentially locking in a new rate at today’s level in case rates rise further. You can do this with many lenders with no obligation to proceed.

If you consider jumping ship early from an existing home loan – for example, to take advantage of a better deal from a rival lender – make sure the savings outweigh any penalties or early exit fees for calling time on your current arrangement.

How does the Bank Rate affect savings?

In theory, a rise in the Bank Rate ought to mean savings accounts pay more interest. However, unlike mortgage providers that tend to pass a rate rise over to their borrowers at the earliest opportunity, banks and building societies are often slower to boost their savings rates.

Even once the benefits have been handed over, the average savings rate is still below the current inflation level of 6.7%. That means your savings are effectively losing money by failing to keep up with this figure.

If you have money set aside, it may be worth using it to pay off debts. Or you could consider using a lump sum to make a mortgage overpayment with the aim of paying less interest over the life of the deal.

How does an increase in the Bank Rate affect other forms of debt?

Most personal loans – ie, borrowing other than mortgages – have fixed rates, which means a hike in the Bank Rate should not affect your repayments.

Interest rates on credit cards, meanwhile, are variable but aren’t necessarily linked directly to a change in the Bank Rate, so the interest rate on your credit card won’t necessarily rise.

However, if you’re taking out a new loan following a Bank Rate increase, you’ll probably be offered a higher rate than was previously available.