Why the Bank of England Base Rate Matters

Every few months, the financial press goes a little bit crazy speculating whether or not the Bank of England is going to raise the base rate.

And more often than not, it doesn’t.

In fact, over the past nine years, the Bank of England’s Monetary Policy Committee (MPC) has only raised rates once – in November 2017, when the committee voted to increase the base rate from a historic low of 0.25 per cent to 0.5 per cent.

But today, press speculation is reaching fever pitch. All signs point to a rate increase to 0.75 per cent – the highest rate since February 2009.

So why does this matter?

The base rate forms the foundation of the UK’s banking system, and it dictates everything from the savings rates that you are offered by your bank or building society, to the cost of your mortgage, and even the overall health of the UK economy.

What is the base rate?

The rate is set by the MPC on a quarterly basis, although historically rate changes are rarely implemented more than once or twice a year.

This all changed in the wake of the financial crisis, when the UK banking system was plunged into chaos and the government was forced to take drastic measures to avoid economic collapse.

In October 2008, the base rate was 4.5 per cent, but by March 2009 it had plummeted to 0.5 per cent.

Then came the Brexit vote, which sent the value of the pound crashing and sparked a period of worrying stock market volatility. By August 2016, the MPC had reduced the base rate yet again, to an all-time low of 0.25 per cent.

Since then, the economy has slowly started to recover, despite the occasional Brexit-related wobble. In fact, many rate-watchers expected a new rise to be announced earlier this year, but the economic fallout from the ‘Beast from the East’ put paid to that. In the first quarter of this year, the UK economy grew by just 0.1 per cent – the worst GDP reading in five years.

However, Mark Carney, the governor of the Bank of England has hinted heavily that he believes this to be a blip.

In June, he said: “The incoming data have given me greater confidence that the softness of UK activity in the first quarter was largely due to the weather, not the economic climate.”

This statement is significant as Carney was one of the six MPC members who voted against a rate rise in May, citing economic growth concerns as his primary reason.

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Since then, there have been mixed results from the UK economy. In the second quarter of the year, GDP rose to 0.2 per cent, thanks to a surge in retail spending. The National Institute of Economic and Social Research has predicted that third quarter growth could reach as high as 0.4 per cent, as the warm weather and World Cup encouraged people to spend more.

However, there has been no shortage of bad economic data to pore over. Factory output is down, productivity is down, export sales are down, and the trade deficit has widened.

Will the rising GDP be enough to convince Carney and co to hike the interest rates? We will find out later today.

What will a base rate rise mean?

An increase in the base rate will mean different things to different people. From an economic perspective, it would be an endorsement of the UK’s ability to withstand Brexit uncertainty and market volatility.

For mortgage owners and other borrowers, it will likely translate to higher fees. This is particularly true for anyone who is using a tracker mortgage, which automatically readjusts any time the base rate changes.

But for savers, the base rate increase can only be good news.

Cash ISA accounts, instant savings accounts and bank-based savings accounts are all likely to raise their rates, even if only by a few basis points.

Ever since the base rate first hit 0.5 per cent back in March 2009, banks have been forced to slash their own interest rates to match, and High Street savers have found it almost impossible to source savings rates of one per cent or above.

An increase of just 0.25 per cent could make a difference to long-term savers, particularly if this money is being held within a tax-free savings wrapper such as an ISA.

More significantly, a rate rise today will raise hopes of another rate rise during the next MPC meeting in November, which could then lead to further incremental increases over the following months.

After all, if it took just six months to bring the base rate from 4.5 per cent to 0.5 per cent way back in 2008/09, surely the reverse is also true.


Also published on Medium.

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Kathryn Gaw

Kathryn Gaw is a financial journalist based in Belfast, Northern Ireland. She has been writing about personal finance and investment trends for more than a decade, and her work has been featured in the Financial Times, City A.M., the Press Association, and The Irish Independent, among many other publications.

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