What are interest rates? How do interest rates work? Will interest rates go up?

Author: Dave Mills

Whether interest rates will change is always the subject of intense speculation by ordinary people as well as financial analysts and commentators. That’s because so much hinges on even the smallest adjustment. Whether you want interest rates to go up or down normally depends on whether you are a saver or a borrower. Here we look at rate-setting dynamics, recent UK interest rate history, and report on what’s likely to happen in the short-to-medium term.

What are interest rates?

Interest rates set the minimum cost of borrowing. If you borrow money, interest rates help determine how much you must pay back.

If you lend your money to a bank in the form of your savings, interest rates help determine how much you will earn on your deposit.

Importantly, interest rates should be considered as the base rate of interest. That’s because banks and building societies add their own retail rates, which enables them to make money and creates an element of hard-fought competition in the financial services marketplace.

What affects interest rates?

Interest rates can be used as a tool to control inflation. If inflation exceeds the UK’s current 2% a year target, then rates may rise to make borrowing more expensive, usually reducing inflation.

However, raising interest rates is a tough call to make. Although many savers will be happy, any rise in borrowing costs could negatively affect economic growth, leading to a knock-on effect on jobs and job-creation. This means the economy must be doing reasonably well if interest rate rises are to be considered.

When an interest rate rise is reported as being likely, we often see an increase in the value of the pound because the news gives currency investors more confidence in the state of our economy.

Interest rates over the last 30 years?

In 1992 interest rates hit the dizzying height of 15%. These high levels led to widespread negative equity for homeowers and house repossessions. It also led to a crash in house prices because people couldn’t afford mortgages.

When New Labour swept to power in 1997, the then Chancellor Gordon Brown handed the power to set interest rates to the Bank of England. The idea was that an independent body would be best-placed to set rates because it would not be influenced by political pressures like ministers in government might.

Following the global economic crisis ten years ago, interest rates were cut to a then historic low of 0.5 % to help businesses and protect jobs. They were cut to a new historic low of 0.25% following the Brexit referendum.

So, what about Brexit?

Brexit is an uncertain variable that clouds the water even further. It’s uncertain because some people predict good things for the economy after Brexit and some people predict bad things.

If goods and services become more expensive after Brexit due to a weak pound and/or the introduction of tariffs, then inflation is likely to rise.

However, the Bank of England would have to be careful when controlling this inflation with any interest rate rise because too big a rise would risk stalling economic growth or even sending the economy into decline, known as a recession.

Will interest rates go up?

The Bank of England’s Monetary Policy Committee has raised interest rates twice over the last year by 0.25% from their historic low of 0.25%, making the current rate 0.75%.

Bank Chairman Mark Carney is on record as saying that interest rates will most likely rise steadily over the coming years. But, by how much and how quickly depends on economic circumstances.

Mr Carney has also hinted that although rates will probably rise, he expects them to reach a new ‘normal’ of around 2-3%, which is relatively good news for most mortgage holders.

A widely-predicted rise to 1% this autumn could still happen. Although this seems less likely now due to lower than forecast inflation.

To clarify anything related to interest rates and the products with which we deal, please feel free to give us a call on 01489 578338 or 02380 428221.

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