UK Interest Rate Statistics

Capital, in essence, is an asset. Capital thus costs money. This financial concept goes back centuries. Nobody, especially banks, lends out money for free.

When a borrower takes someone else capital, the borrower has to repay the sum with interest. The level of interest to be repaid is often called the rate of interest.
In modern times, there is a base level of interest rate that other debt instruments are priced off. This basic interest rate (the ‘policy rate’) is controlled by a country’s central bank.

Here in the UK the Bank of England controls the interest rate called the Base Rate. This is the rate which it charges other commercial banks like Barclays or Lloyds. Many debt agreement, such as mortgages, are priced off this Base Rate.

• Current UK Interest Rate: 4.5%
• Previous BoE Rate: 4.75%
• 1 year High: 5.25%

UK Interest Rate History

What affects the level of interest rate?

Interest rate, at the most fundamental level, is a function of aggregate supply and demand.

When the demand for capital increases,  interest rates usually go up. When supply of capital exceeds demand, rates drop. What determines supply and demand is the overall business conditions.

During a cyclical upswing, the demand for capital increases since businesses are eager to expand. Rates naturally climb. In a recession, the opposite occurs. Corporations retrench; household save. Few would want to incur debt. Rates fall in this environment.

Of course, the above is only a crude way of putting it. There are other economic factors that could impact the level of interest rate.

The most relevant consideration is the rate of inflation. One of the most important tasks of a central bank is to control inflation.

To this end, the central bank adjusts one of the most powerful tool in its arsenal – the policy rate – to combat and bring down inflation. The general rule is that when inflation rises persistently interest rate goes up – and vice versa.

Can interest rates be negative?

Yes, they can. In the years leading to the pandemic and during the pandemic, interest rates in a few advance economies were below zero. The chart below shows how much interest rates were stuck in minus territories.

In Europe, for example, the ECB Deposit Rate was stuck below zero for seven long years! Another country that had low/negative interest rate was Japan, the first country to implement quantitative easing in 2003.

Source: yardeni.com

When were UK interest rates highest?

According to the Bank of England data, UK interest rate reached its peak in the seventies.

In 1980, for example, the Base Rate skyrocketed to a record 17 percent (see below). Since then, there were episodes when rates climb rapidly to double digits, but none came close to this summit.

Interest rates were very volatile in the decade (1970s) because of a) a sudden supply shock in energy (due to OPEC restrictions) and b) food shortages. Inflation rates were in double digit for a good few years.

Since then, interest rates have been falling – and reached a record low of 0.1 percent during the pandemic.
Source: BBC (2017)

Who decides the base rate?

Since 1997, the Base Rate is decided by a committee of financial experts, called the Monetary Policy Committee (MPC, link).

This nine-member committee, headed by the governor, will meet eight times annually to deliberate on the Base Rate. MPC members are well attuned to the economic trends and they produce the Monetary Policy Report to outline their economic reasonings in adjusting the policy rate.

After each meeting, one of these following rate decisions will be made: Raise, lower, or unchanged. The path will be decided via voting.

How often does Base Rate change?

In recent years, the Monetary Policy Committee will gather around eight times per year to decide on the important Base Rate.
During each meeting the MPC will consider the economic outlook, analyse potential downside risks, and deliberate if the current policy rate will achieve the Bank’s targets such as inflation (currently targeted at 2 percent).

Sometimes, the rate will stay unchanged for a few meetings if the majority prefers to wait for further clarification before acting. This happened during March 2020 – December 2021.

From late 2021 to mid-2023, however, the MPC hike interest rate fourteen times as inflation rates spiked. On the other hand, during a financial crisis, an extraordinary (emergency) meeting may be called to drop rates.

In a nutshell, the Base Rate may change more frequently than you would expect.

Source: BBC

How does the base rate work?

One principle that underpins modern monetary system is the fractional banking system. The central bank controls the money supply and price of short-term credit – interest rates.

Commercial banks then price their products, such as mortgages, off this policy rate.

When economic growth slows, the central bank stimulates activities by lowering the policy rate (Base Rate). At the opposite end, when economic activities pick up, the central bank increases the Base Rate to slow down these activities in order to temper the inflation rate.

The main task of a central bank, in the words of the former Fed chair William McChesney Martin, is to “ordered the punchbowl removed just when the part was really warming up.“

How does the base rate affect mortgages?

Mortgages are long-term capital lending plans for people to buy homes.
Banks advance a large sum to homebuyers and they, over a long period of time, pay the bank regularly a smaller sum of money. Banks make money by charging interest on these vast sums. As of 2024, the total amount of mortgages advanced to homebuyers was £1.6 trillion.

Mortgage rates are interest rates that banks earn from mortgages. These rates loosely follow that of the Base Rate. I say loosely because mortgage rate trends are based on general market supply and demand.

Look at the chart between the Base Rate and mortgage rates. Broadly speaking, they tend to go up and down together.
Therefore, when the Bank of England cut rates, homeowners pay a little less on their monthly mortgages. This frees up money to be spent on other household goods.

Source: Moneyfactscompare.co.uk 

How does the base rate affect savings?

The general trend is that when Base Rate rises, the average saving rates climb in tandem. Savers benefit from earning more interests on their hard-earned capital.

However, remember that savers put their money in regulated commercial banks such as Barclays and Lloyds, not the Bank of England.

Commercial banks strive to remain profitable by maintaining an interest spread between lending and deposits. Therefore, commercial banks do not pay all savers the full base rate.

For example, when the Base Rate was at 5.25 percent last year, easy access rates were at 3.12 percent. Savers may have to lock up their capital for a fixed period to benefit fully from the current Base Rate.

When interest rate was near-zero in 2021, saving accounts earn very little interest.

Source: Moneyfactscompare.co.uk 

How does the base rate affect investments?

This question is much harder to answer because the relationship between interest rate and investments are more complex and dynamical.

Generally speaking, higher borrowing costs make investments more expensive. Corporations are forced to spend more money on projects, be that on infrastructure or equipment. Corporate debt costs increase when interest rates rise, since lenders demand more interest on borrowings.
Companies with lower cash resources may have to curtail investments.

In sum, returns on corporate projects fall when interest rate rises significantly.
However, there are many other factors that could counter this, such as available cash balances, projected business growth rates, market confidence, and the level of borrowing costs etc.

Moreover, not all companies are equal. Some have better credit quality (eg Apple Inc). These blue-chip firms a larger borrowing capacity and lower debt costs.
By and large, equities value (stock market) increases when interest rates are low. This relationship for example, can seen in the US between the Fed Funds Rate and the S&P 500 Index during 2010-2014.

Source: etftrends.com (2024)