You’ve probably heard a lot about interest rates over the last 18 months and you aren’t alone. Whether you have a mortgage, savings account or credit card interest rates affect your financial live in way you likely don’t even realise. But what exactly are these rates? Why do they change? And more importantly when can we expect them to change again – for the better?
Lets look break this down in simple terms and not typical Bank jargon so you know exactly what’s going on.
What Are Interest Rates?
Put simply interest rates are the cost of borrowing money or on the other hand the reward of saving it. If you borrow money from a bank (such as through a loan or mortgage) the interest rate determines how much you will pay back on top of what you borrowed. On the other side of the coin, if you save money in a bank account, the interest rate will show how much you will earn as a reward for keeping your money with them.
Unfortunately because the interest rate to borrow is high that doesn’t mean it will be to save.
For Example:
- If you take out a £10,000 loan with a 5% interest rate, you’ll pay £500 in interest over a year.
- If you save £1,000 in an account with a 2% interest rate, you’ll earn £20 in interest over the same period.
Who Decides Interest Rates?
Here in the UK interest rates are set by the Bank of England. This isnt like your normal high street bank where you open a savings account. The Bank of England is the UK’s central bank and has the responsibility of keeping the country economy stable.
Every few weeks a group of ‘experts’ call the Monetary Policy Committee (MPC) meets to discuss the state of the economy. What’s their role? Their main goal is to keep inflation in check.
Hold on….. what’s inflation I hear you ask?
Inflation is just a fancy term to demonstrate how much prices are going up over a period of time. Look at it this way, you’ve gone to the shop to by a loaf of bread, it now costs £1.10 but last year is cost £1. That’s inflation – the price of goods and services increases.
The Bank of England wants to try keep inflation around 2% each year. However if prices increase too quickly, peoples wages don’t go as far. On the other hand if prices don’t rise at all or even fall (called deflation) it can be equally bad for the economy.
How Do they Affect Inflation?
So why are interest rates affected by inflation? Here is how it works:
- If inflation is too high (prices are rising too fast) , the Bank of England may choose to raise interest rates. This makes borrowing money more expensive, which slows down the rate of spending and cools down the economy
- If inflation is too low (prices aren’t rising fast enough), the Bank of England may lower interest rates to make borrowing cheaper, as such encouraging people to spend and invest.
In short, interest rates are one of the key tools the Bank uses to control the speed of the economy.
Why Don’t Interest Rates Just Change Whenever We Need?
Seem logical doesn’t it? Why not just lower interest rates when things start to improve. The reason interest rates don’t change over night is because the economy is like a giant ship, it takes time to turn around. The Bank of England needs to think carefully before making decisions.
Sometimes they will predict inflation will rise in the future and raise rates early to combat this despite things seeming fine now. Other times they will leave rates unchanged to give the economy time to react earlier to decision.
What’s the Latest for Interest Rates in 2024?
Throughout 2024 the UK has been experiencing higher interest rates than most people are used to. Over the past few years the Bank of England has steadily increased interest rates to combat high inflation. In 2022 and 2023 inflation soared primarily due to global factors like supply chain issues, the war in Ukraine and the lingering effects seen from Covid.
These events all pushed the cost of goods up, in turn the Bank of England responded by raising the interest rates.
Where Are Interest Rates Now?
- The Bank of Englands base rate currently stands at 5%, dropping from 5.25% in August. The first time we’ve seen it cut since Covid.
- This means borrowing is more expensive. If you’ve got a variable-rate mortgage or loan you are paying more. However it does mean those fortunate enough to have savings are getting better returns (But only if the banks pass on those higher rates to you)
When Will Interest Rates Change Again?
No one can predict the exact dates, however many experts are predicting it will come down to 4% before the end of 2024 and 3.5% by the end on 2025. If inflation does continue to come down towards the Banks 2% target the MPC could decide to pause rate hikes or even cut rates slightly to stimulate growth.
However as the predicted time period above shows we should be prepared for a slow recovery. he Bank of England will likely keep rates high until they’re certain inflation is under control. So, any major changes in interest rates might not happen until late 2024 or early 2025.
What Does This Mean for You?
- Mortgage Holders: If you’re on a fixed-rate mortgage, your payments won’t change until your term is up. If you’re on a variable rate or tracker mortgage, you’ve probably already noticed your payments increase. It might be worth considering switching to a fixed rate if you think rates will go up further.
- Savers: This is good news for savers! Higher interest rates mean better returns on savings accounts. Shop around for the best deals, as not all banks will offer the highest rates straight away.
- Borrowers: If you’re thinking of taking out a loan or getting a credit card, be aware that borrowing is more expensive right now. Try to avoid unnecessary debt until rates come down if you can.
What Can You Do?
- Review your finances: Look at your mortgage, savings, and any debts you have. Consider refinancing options if rates change significantly.
- Plan for the future: Interest rates affect your day-to-day life, so planning ahead can save you money. Whether it’s locking in a mortgage deal, saving in a higher-rate account, or cutting back on spending, small changes can make a big difference.
Final Thoughts
Interest rates may sound complicated, but they play a crucial role in how much we spend and save. As of 2024, we’re in a period of higher rates to fight inflation, but changes could be on the horizon later this year. Keep an eye on the news, and make sure to stay informed about how it impacts your personal finances.
For more updates on interest rates and other financial topics, keep checking back with AnswerNow.co.uk!
