How The Bank of England set interest rates

Q. How does the Bank of England decide and set interest rates? The Bank of England set the repo rate. This is sometimes known as the ‘base rate’. It is the interest rate at which commercial banks (like Lloyds and Natwest) borrow from the Bank of England. The Bank of England can control liquidity and money supply, so commercial banks need to borrow short-term money from the Bank of England. This means this repo rate is important for commercial banks….


Interest Rate Cycle

The interest rate cycle is closely related to the economic or trade cycle. In theory, movements in interest rates should mirror the economic cycle. If the economy is growing strongly and inflationary pressures increasing – Central Banks will increase interest rates to slow down the economy and prevent inflation. If the economy enters into recession with falling inflation and rising unemployment – Central Banks will cut interest rates to provide an economic stimulus to try and increase the rate of economic growth. Interest rates in US 1994-2017


Who benefits from low interest rates?

When interest rates were cut to 0.5% in March 2009, few would have predicted that interest rates would have stayed low in UK, US and the Eurozone for so long. Interest rates have stayed at zero for several years – defying several predictions that they will rise soon. Who benefits from low-interest rates and who loses out? Beneficiaries of low-interest rates 1. Homeowners with variable mortgages The big winners from a period of low-interest rates are homeowners who are paying a variable mortgage. Firstly, low-interest…


Investment and the Rate of Interest

An explanation of how the rate of interest influences the level of investment in the economy. Typically, higher interest rates reduce investment, because higher rates increase the cost of borrowing and require investment to have a higher rate of return to be profitable. Private investment is an increase in the capital stock such as buying a factory or machine. (investment in this context does not relate to saving money in a bank.) The marginal efficiency of capital (MEC) states the rate of return on an investment project. Specifically, it refers…


Real interest rates

The real interest rate is the nominal interest rate – inflation rate. For example, if the Bank of England set base rates of 5.5% and the CPI inflation rate is 3.4%. Then the real interest rates is said to be 2.1% A higher real interest rate is good for savers and bad for borrowers. Note, even if nominal interest rates were high e.g. 11%, savers would see a decline in their real value of money if inflation was 12%. This is why the real interest rate is important Real interest rates can be…

How do interest rates affect savers and saving levels?

Interest rates determine the amount of interest payments that savers will receive on their deposits. An increase in interest rates will make saving more attractive and should encourage saving. A cut in interest rates will reduce the rewards of saving and will tend to discourage saving. However, in the real world, it is more complicated. The link between interest rates and saving is not clear because many factors affect saving. In 2009, the household saving ratio increased from 0.5% to over 8%…

Interest Rates and the Economy

Interest Rates and the Economy

Readers Question: Hello can you please tell me what the disadvantages of using interest rates would be for the economy? Interest rates are used to try and achieve low inflation and stable, sustainable economic growth. However, interest rates are limited, they can’t always achieve all the governments’ macroeconomic objectives at once. Interest Rates and Inflation For example, if an economy is overheating (with inflation increasing), a rise in interest rates can help to reduce the growth of aggregate demand and reduce inflationary pressure. If implemented correctly,…