Every month, a panel of influential experts at the Bank of England meets to decide whether to change the current Base interest rate.
Changes to the Base rate can have a knock-on effect to consumers in terms of the interest you pay on borrowing and the interest you receive on savings. But what is the Base rate? And how does it affect you? Keep reading for our full guide.
What is the Base rate?
The Base rate of interest – sometimes called the ‘official bank rate’ – is the interest rate at which a central bank lends to other banks.
In the UK, the central bank is the Bank of England. So, the Base rate is the rate at which the Bank of England lends to retail and merchant banks.
The Base rate is set by the Monetary Policy Committee (MPC). This is a board of nine economists and financial experts and they meet every month to decide whether to change the rate.
Individual banks are free to set their own interest rates for things like mortgages, loans and savings. However, these rates tend to be derived from the Base rate, meaning that mortgage and savings rates typically follow changes to the Base rate. This allows the Bank of England to use the Base rate to encourage or discourage spending, depending on the current state of the economy.
For example, increasing interest rates discourages spending and encourages saving. This can help to cool the economy, which helps to reduce inflation.
The last Base rate change was in November 2017. The MPC voted to raise the Base rate from 0.25% to 0.5% based on factors including low unemployment, rising inflation and stronger global economic growth.
How has the Base rate changed in the past?
In 2008 and early 2009 the Bank of England slashed the Base rate in response to the global financial crisis. The Base rate remained at 0.5% from March 2009 until August 2016 before reaching a record low of 0.25% in the autumn of 2016.
This period represented a historic low for the Base rate. Before then, the Base rate had typically been much higher, sitting around the 5-6% mark for the previous decade. For most of the 1980s, the Base rate was around 10%, and it even rose as high as almost 15% in 1989.
How does a Base rate change affect my mortgage?
Whether a change to the Base rate will affect your mortgage will depend on the type of mortgage you have.
Fixed rate mortgage
If you have a fixed rate mortgage, then your interest rate is guaranteed for a fixed period. This means that if there is a change to the Base rate, you won’t see your interest rate or monthly repayments change.
A fixed rate will ensure your repayments don’t rise in the event of a Base rate increase. However, it also means that you won’t benefit if the MPC were to reduce the Base rate.
Discounted variable rate or Standard Variable Rate mortgage
A discounted variable rate means that your repayments are based on your lender’s Standard Variable Rate (SVR).
You may also be on your lender’s Standard Variable Rate, perhaps because your previous deal has expired.
When the Base rate changes, lenders will often raise or lower their Standard Variable Rate. They can do so by the same amount but have the discretion to make larger or smaller changes should they wish.
This means that if the Base rate does change, you can also expect your discounted variable or SVR mortgage repayments to change.
However, a lender is not obliged to change their SVR when the Base rate changes. For example, when the Base rate fell sharply in 2008, many lenders did not reduce their SVRs by the same amount.
Tracker rate
Of the 8.1 million households with a mortgage, 3.7 million – or 46% – are on either a Standard Variable Rate or a tracker rate.
If you have a tracker mortgage, this will generally be directly linked to the Base rate (you typically pay a percentage over the Base rate). So, when the Base rate changes, your mortgage rate and your monthly repayments will be directly affected.
For example, according to UK Finance the average outstanding mortgage balance is £89,000. When the Bank of England decided to raise rates by 0.25% in November 2017, the average mortgage payment increased by about £12 a month.
How does a Base rate change affect other borrowing?
Many banks and other financial institutions use the Base rate as a guide for pricing other products.
So, when the Base rate changes – particularly if it rises – you can expect the interest rates on things like personal loans and credit cards to also rise.
Barclaycard suggest that a 0.25% rise in the Base rate means an additional 21p a month interest for every £1,000 of your balance (this doesn’t include a promotional balance).
How does a Base rate change affect my savings?
Banks and building societies have the freedom to set the interest rates they charge on their savings products, such as ISAs or regular savings accounts.
However, interest rates generally mirror what is happening to the Base rate. So, if Base rates rise then savings interest rates will also generally rise.
The most recent Base rate increase of 0.25% was considered good news for savers as it increased the interest rate many received on their cash savings.